EXPERIENCED TRADERS KNOW THAT UNDERSTANDING RISK AND FINDING EFFECTIVE WAYS TO MANAGE IT ARE FUNDAMENTAL PARTS OF A SUCCESSFUL TRADING STRATEGY
While the risk of loss is embedded within the very nature of trading, keeping potential risk factors towards the front of your mind as you consider your options can greatly reduce the possibility of placing an unsuccessful trade.
With financial betting, there are two major risk factors to consider: volatility and leverage.
Volatility
Markets can move quickly and unexpectedly. Major earnings announcements, political upheavals, or natural disasters are some of the events that can impact equities, bonds, and commodities. While volatility can provide trading opportunities, it can also pose significant risks. There is no way to completely avoid volatility in the market, but you can learn to manage the risks it poses to your trading.
Leverage
Spreadbets are traded on leverage, which can be both a benefit and a risk. Leverage allows you to take a larger position with less capital, but a high degree of leverage can work against you as well as for you. When you trade, keep in mind that the leverage on your spreadbet is a significant factor that can magnify both positive and negative outcomes. You may end up losing more than your initial deposit.
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Risk Management
Whilst the financial markets offer savvy investors the opportunity to make a good profit, there is undoubtedly the strong possibility of heavy losses. It’s, therefore, important to have a well-planned risk management strategy in place to prevent your account being wiped out within a few trades.
Regardless of whether you trade stocks and shares, forex or spread bet on a variety of markets, it is important to take whatever steps you can to minimise potential losses and cover yourself if things go wrong.
Knowing when to stop
Stop losses are an important tool that helps investors to rapidly close their position if things start to go drastically wrong. They ensure that even if their human eye misses a market swing, the order is still executed. When opening a position, a trader can specify at what point they want their trade to be closed. This needs to be set wide enough to miss normal market fluctuations but close enough to ensure a true rebound in market trend is picked up early and losses are minimal.
It therefore takes some skill to estimate where to set a stop loss and the actual point will vary on the market being traded as well as the risk attitude of the investor. Once the stop loss has been placed, as soon as the market touches the specified point, even if only briefly, the position will be automatically closed out. This means if an investor steps away from their trading platform whilst they have a position open, they need not fear missing a dangerous market movement, as they know the risks are covered.
If the broker receives a lot of orders simultaneously there may be a small delay before the order is executed; this is known as slippage. To prevent this a trader can opt for a guaranteed stop loss but some brokers charge an additional fee for this.
It is also possible to lock in profits in a similar way using stop wins. This allows a position to be closed automatically once a pre-determined level of gains has been earned. This may not sound like a risk management strategy but in reality once a trade reaches the top end of its movement it can very quickly retrace, resulting in losses. It’s therefore important to exit the market at the right time.
Covering your costs
Some investors use the market to hedge against existing costs to protect their profits elsewhere. For example, a cruise liner relies on oil and this can be a major cost for a company with a fleet of ships. They may opt to invest in a market that brings a profit if the price of oil rises, helping to offset the additional costs of purchasing it. If, of course, the price of oil moves in the opposite direction, the company profits by being able to buy cheaper oil but the investment suffers.
One way to avoid this is by investing in a market with no set expiry date, thus allowing the position to ride out any lows and closing the trade to collect the profit when the price rises. This is known as hedging and can be a very effective strategy. However, it needs to be planned very carefully and the relative costs and prices on each side calculated inscrutably.
There’s no getting away from the risks that are inherently involved in trading, but by using every tool possible, investors can minimise their potential losses without compromising their possible gains.