Trading CFDs is a flexible way to back your judgement on a range of financial markets. However, without an effective risk management strategy, it can also lead to substantial losses. It is therefore important to understand risk and learn how to manage your portfolio effectively.
Why do I need to manage risk?
Leverage
Unlike most traditional financial trading services, CFDs are a leveraged product. This means that your initial deposit payment gives you exposure to a comparatively larger portion of an underlying market than if you bought the instrument directly (via a stockbroker for example). Leverage is one of the key advantages of CFD trading, as it allows you to profit from a market without having to put up the full value of the position.
However, this magnified exposure also means that CFDs can result in losses that exceed your initial deposit.
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 essential 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.
We offer regularly updated Economic Indicators, including analyses of upcoming financial announcements, as well as a market commentary to keep you up-to-date with major financial events.
Enrolling in our TradeSense course will allow you to benefit from a full module on risk management, including information about how to maintain a balanced portfolio and manage your personal risk/reward expectations. We also offer a range of free, online seminars.
Monitor your open positions
An equally important 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 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.
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.
Risk and Account type
The amount of risk you are willing to take may affect your choice of account. We offer two main accounts, the Limited Risk and the Trader Account.
With a Limited Risk Account, a Guaranteed Stop is placed on every position you open and you can generally not lose more than the amount of your initial deposit. Please note however, if you place a trade denominated in a currency other than your base currency, you will be exposed to currency fluctuations. We may then convert any profits or losses in this currency to your base currency. Due to the possibility of currency fluctuations, this could result in your account incurring a further loss, beyond your initial deposit.
The Trader Account allows you to place trades with or without Limited Risk. If you open a position without a Guaranteed Stop and the market moves against you, you must have sufficient cash on your account to fund the deposit requirement as well as the total of your running losses. If you do not, we may cut back or close your open positions. If we choose to do so, this can help prevent your losses becoming more substantial. While this offers some level of risk protection, you should not rely on us to close your losing positions.
The Select Account, which is not available to open online, does not require immediate margin payments. As such, if you are using this account type, it is important to monitor your positions closely.
Find out more about the range of accounts we offer, and our TradeSense education programme, which allows you to begin trading in smaller than usual minimum deal sizes, so you can limit your exposure as you build your confidence..
Or, if you're ready to start trading CFDs now, you can open an account online in minutes.