Part 7 - How do I manage risk?

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There are three main considerations when opening a position with a CFD.

1) You must understand your market.

Before placing a trade, you should know your market and assess its probability for volatile movement. This is crucial in calculating the potential risk of the trade. Historically, some markets have shown a tendency to jump less suddenly, while others, such as equities, are more prone to making quick, pronounced moves (often caused by profit warnings or company news).

2) It is essential to monitor your open positions.

Volatile markets can move hundreds of points in the space of minutes. A good understanding of your market is a start, but you should actively monitor your account so that you can react to any sudden market moves.

3) Use stop-losses and Llimit orders.

It may not always be possible to micro-manage your open positions, which is why placing stop orders should be a vital part of your risk management armoury. A stop loss order can be set to trigger an exit point as pre-determined by the trader eg Buy at 300p with a stop loss at 260p. Once the stop loss is triggered, a sell signal is activated to the CFD provider and actioned in accordance with their terms of business and taking into account available liquidity to action the request.

The most effective way to manage risk is to use guaranteed stops, which, in return for an upfront premium, put a fixed limit on your potential loss without putting a cap on your profits.

If prices move against an open CFD position additional funds could be required to maintain the margin level. The CFD provider may call upon the trader to deposit additional sums to cover this, and in fast moving markets this may be at short notice. If funds are not provided in time, the CFD provider may close or liquidate the positions at a loss for which the trader is liable. That is not a position any self-respecting trader wants to find himself in.

There is something peculiarly compelling about betting your favourite markets with someone else's money. During an absurd bull run profits can flow as quickly as they did for mortgaged-up-to-the-hilt homeowners between 1998-2008. But as homeowners have discovered in the last couple of years, the experience of owning something that you bought with money that is not your own can quickly turn sour.