A risk management strategy is very important for you to integrate when trading CFDs. This should be part of your trading routine and if you fail to formulate it, you will have a difficult time adjusting and sustaining a profitable trading account.
The first task you have is to decide the amount that you are willing to risk as well as your profit target on a particular time frame. After determining these things, it is time to enter a trading position. But before that, you should create a risk management plan and determine your risk-reward ratio. You must also understand the leverage which is being offered by your broker.
Getting To Know Contracts For Difference
Contract for Difference (CFD) is a leveraged product that permits the trade of several instruments such as commodities, shares, indices, currencies, and cryptocurrencies. There are currently a lot of brokers offering CFD, especially when dealing with currency pairs. The broker-trader relationship in CFD goes on like this – if you buy or sell a CFD, you’re responsible for paying the difference between the opening price and the closing price of the asset in the market. You don’t also need to own the underlying asset to start trading. As long as you pay the margin, then you can start with your trades as soon as possible.
Risk Management in CFD
In any trading you partake, it is important to create a sustainable risk management plan that has to be incorporated with your trading strategy. This plan should be based on your risk tolerance. Every time you develop a trading strategy, it should always be based on your trading plan, which mainly describes the amount of risk that you are willing to take and the gains that you expect to have. One trader is different from the other. Therefore, it is important to have your own risk management plan, unique from other traders. A unique risk management plan contains the trader’s risk tolerance and other important information unique only to every trader.
The Risk-Reward Ratio and Profit Factor in CFD
For successful traders, they are aware that they should take on more risks to gain more in CFD trading. There are two ratios that you need to understand following this process – the risk-reward ratio and the profit factor.
The risk-reward ratio is the trader’s reward divided by the risks. If you follow your trading strategy, you tend to gain more than the amount that you lose. For instance, you won $2 on every trade and lose $1 on losing trade. This makes 2:1 your risk-reward ratio. This ratio is beneficial especially to new traders. When dealing with CFDs, you have to decide on a particular risk-reward ratio and stick to it no matter the circumstances in the market.
The profit factor ratio, meanwhile, is the trader’s gross winning trades divided by the gross losing trades. You can also multiply your average win rate by the winning percentage then divide it by the average rate of your unsuccessful trade multiplied by your losing percentage.