CFDs are a flexible way of backing your judgement on a range of financial markets. Without a considered risk management strategy, however, CFD trading can lead to losses greater than your initial deposit. It is essential to understand risk and learn how to manage your portfolio effectively.
Why do I need to manage risk?
Leverage
Unlike assets traded in a traditional sense, CFDs are leveraged, meaning your deposit gives you exposure to a significantly larger amount of the underlying market than if you invested the same amount in the asset directly (via a remisier for example). Leverage is a key benefit of CFD trading, as it lets you profit from a market without putting up the full value of your position.
This magnified exposure also means that CFDs can result in losses that exceed your initial deposit, equal to those of the full value of the trade. It is important you understand the associated risks of leveraged trading.
How do I manage risk?
Understand your market
Before trading, it is important to understand the market on which you are taking a position. Knowing the potential for each market to experience volatility and establishing the likelihood of sharp price movements is key when considering the risk associated with each trade. For example, historically, some markets are less likely to make sudden discontinuous jumps, while others, such as shares (which can be subject to profit warnings and other news), may be more likely to make abrupt movements.
Through our website you have access to our free Market Resources, which include analyses of forthcoming Economic Indicators and a weekly calendar for key financial announcements.
Our TradeSense programme provides a full module on risk management, including guidance on how to maintain a balanced portfolio and manage your personal risk/reward expectations. You will also find several seminars regarding risk management among our archive of free online seminars.
Monitor your open positions
Another key risk management strategy is simply to closely monitor your open positions. Volatile markets can move hundreds of points in minutes, and while a good understanding of your market may help you pre-empt extreme fluctuations, there is no substitute for actively monitoring your account.
To help you manage risk without capping your potential for profit we offer a powerful range of tools, including Watchlists, Alerts and free mobile-dealing software.
Using Stop orders
When you open a position, the most effective way to manage risk is to put an absolute cap on your potential loss by using a Guaranteed Stop. This means that you specify the level at which you want your position to be closed should the market move against you. In return for a one-off extra charge, in effect an insurance premium, we then guarantee to close your position at that exact point, even if the market gaps suddenly. With a Limited Risk position (a position with a Guaranteed Stop attached), your maximum possible loss is known as soon as you open the trade, making it an extremely effective risk management tool.
We also offer non-guaranteed Stops, which do not incur the premium associated with Guaranteed Stops but can also help manage risk. A non-guaranteed Stop will trigger an order to close your position once the selected level has been reached. However, you should be aware that it will sometimes not be possible for the Stop Order to be transacted at the price you have selected. This may happen overnight or when the market moves very quickly. In these cases the Order will be transacted at a worse, and sometimes much worse, level than you have selected. This is known as 'slippage', and is determined on a basis which IG believes to be fair and reasonable. For more details on slippage see our CFD glossary.
Trailing Stops are non-guaranteed, but track your position while the market moves in your favour, providing protection if it starts to move in the other direction. This allows you to lock in profits without the need frequently to re-adjust the level of your Stop. Read more about Trailing Stops.
Using Limit orders
A limit order triggers an order to close once a specified market level has been reached. It is an instruction to take profit if prices move in your favour. This means you can realise a pre-selected level of profit, even if the price later moves against you.
Stop and Limit orders are available over the phone as well as online, meaning you can manage risk wherever you are.