CFD traders have many tools at their disposal to help make successful trades, and one of the most important is the stop loss order. As a contract for difference is a leveraged product, there is always the possibility of a position turning bad and leading to a catastrophic margin call. Obviously, this isn’t something that should be expected to happen all the time, especially if a trader has done their research and given due diligence to working out whether a position is the right one to take at a given point in time. However, every successful trader will know that when things go wrong events can get out of hand very quickly, so knowing how to use a stop loss order to your best advantage is key for all CFD traders, at any experience level.
Once it has been accepted that every trade won’t be a favorable one, a state of mind can be achieved whereby managing trades effectively can become much easier. Markets can change quickly and that is exactly how CFD traders make money, but even with the most carefully planned trades based on accurate analysis results, there will always be room for the unexpected to happen.
One of the biggest things to get right from the very beginning of trading is working out a risk/reward ratio that is acceptable and then applying a suitable risk management strategy to compliment it. Every trader will be different in this respect, so it really is up to the individual to come to their own conclusions. In general, the more speculative the market or asset chosen, the higher the risk. CFD trading can suit people with an aggressive risk profile, but it doesn’t mean that a more managed and cautious approach can’t work equally well.
That’s where stop-loss orders really come into their own. Using limit orders allows automation to be put in place that means a trade can be exited at a predetermined price and a stop loss order specifically protects the downside of a trade that hasn’t worked out to plan. Even so, sometimes markets or shares gap overnight creating an area where the order cannot be fulfilled, meaning that stop loss orders are not totally guaranteed. However, risk guaranteed stops can be used which ensure the trade is closed at a chosen level no matter what, although these can mean a wider spread is charged by some brokers.
In order to be successful in any trading environment, a detached or ’emotionless’ approach needs to be taken, and this is especially true when it comes to CFDs. The ability to get out of a losing position at the right time is key to success, and therefore hunches, guesses and feelings have no place in the decision-making process. Moving stop levels in response to events can be fatal, so making sure that predetermined targets are in place before opening a trade can be a vital element in continued successful trading.
How to manage a losing position
Learning how to manage a losing position is not something that should be seen as a negative or as planning for failure. Instead, it is a basic element in understanding how trading environments work and established a ‘best practice’ methodology that is essential for long-term success. Knowing never to average down a losing position is something that would seem to be obvious but often gets ignored. Quite simply, when a trading position moves in the wrong direction it need to be cut loose, as holding on to losing trades can mean far more than making a loss in that particular instance.
This is because capital tied up in a losing position, even if it is leveraged, still represents funds that could be put to better use elsewhere. Of course, the question of a margin call also comes into the picture and is something that should always be treated with the greatest respect.
A trade exit point being set correctly is subject to several other considerations.
Having a certain stop-loss level provides a trigger point that executes an order, but ‘gapping’ or ‘slippage’ can come into play. If a stop-loss is activated when price trades are at or below the nominated stop level, occasionally this can lead to the stop order being executed at a price that is less than the one nominated as the stop-loss price. This ‘slippage’ results in bigger losses than would have been anticipated.
It might seem counterintuitive to say that sometimes the best way to make money from trading is to stop trading, but this applies to CFDs as much as it does to any other area. Periodically taking time out to re-evaluate markets, assets and the methodologies used to pick trades isn’t something that only needs to be done after a string of losses. Taking a good look at how all the various tools, strategies and opportunities that CFD trading offers from a new angle every now and again, means that attention to detail can be refocused and the chances of becoming slack by complacency are reduced.