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Risk Management Tools

Risk Management Tools
Written by Andy

When you trade, you inevitably take on risk. There is no “sure thing” in trading, just higher or lower probabilities of success. As a trader, you assess the risk, compare it to the potential reward, and decide whether it fulfils your trading objectives.

While risk management is your responsibility, you will find that different CFD providers give you a range of risk management tools (i.e. stop-loss orders) to help manage the risk, and as part of your selection of a provider you need to take this into account. You do not want to be in the position of thinking, for example, that a trailing stop would be ideal in a certain situation, and then finding that the CFD broker you are using does not offer it.

In this perspective, Guaranteed stops offer complete protection from any market ‘slippage’ while trailing stops can help you run trades for longer maximise profits in the process.

Guaranteed Stops

Some traders find that a guaranteed stop loss fits their risk profile. The GSL works better than a regular stop loss order, in that it guarantees the price at which you will exit the trade if it runs against you. As you probably know, a stop loss order merely becomes an order to sell when the stop loss level is reached, so it does not give any guarantee of how much the market will pay for your position when you exit. Often you will get close to the stop loss level, but if the security is thinly traded or there is a panic you may lose more than you anticipated.

Not all CFD providers offer guaranteed stop losses. The provider has to stand behind the price, and since the price may not be available in the underlying market, there is a charge for all guaranteed stop loss orders, and you pay that charge even when it is not needed. Many traders hesitate at incurring this cost on a regular basis, although in certain circumstances it may be worthwhile.

Trailing Stops

As mentioned above, another useful tool for risk management is the trailing stop loss. The level of the stop loss “trails” up behind the price, at a chosen distance, but never goes down, so when the price drops the position is liquidated. This is useful for ‘set-and-forget trades’, where the market starts moving in the right direction but you don’t know how far it may go before retracing. It needs no further manual intervention on your part to achieve most of the theoretical gains available – just less than the maximum price by the distance you chose to trail behind. This is a very convenient tool to lock in your gains, and it is well worth making sure that the CFD provider you are considering offers it. It is widespread, but one or two brokers do not provide it.

The standard basic risk management tool which you will find from practically every broker is the stop loss order. A stop-loss order is basically one effective way to minimise potential losses and to protect your trade profits. It allows you to set a level of loss at which you want your position closed out. As mentioned above, you are not certain to exit the trade at this exact stop loss level, but you should get reasonably close to it. You should check how easy it is for you to change stop loss levels and update values manually as your trade profits, so that you are able to lock in the gains you have made. Whatever you decide, make sure that your chosen CFD broker allows you to place stop loss orders and supports changing them as your trade progresses without charging you extra for doing so.

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