How do I manage the risks associated with trading CFDs?

There is a long list of risks that are associated with CFD trading. Some you might have expected to see, some may be factors you initially overlooked. What is of fundamental importance is that each risk factor has the potential to cause you significant losses and could even wipe out an account. When they act in unison, that’s when things get really ugly. It’s important you get an understanding of each item in ‘The ‘List of Risk’, but to mitigate them it’s crucial to put them into the context of your trading. It might help to develop an approach that breaks ‘risk management’ down into its constituent parts. Establish: What is at risk? How do I Measure risk? And thenmove on to: How do I Manage risk? Ask yourself if you are approaching the subject assuming it is a case of, ‘when’ not, ‘if’ some risk event is going to occur.

What is at risk? 

The capital you put up to trade is the primary focus when considering risk. But your trading discipline is something else that needs to be monitored and managed. Whilst both of these are inter-related building a trading strategy that considers both can help prevent losses.

How to measure risk? 

This is an important step and involves gaining a clear understanding of what risks you are facing, their likelihood, and the impact to your account when they occur. A lot of traders jump straight to ‘risk management’ and find themselves trying to manage something they haven’t exactly identified.

How to manage risk? 

There are a variety of tools and techniques available. One of the most effective is sitting on your hands and remembering the old adage ‘some of the best trading decisions you make involve not putting on a position’.

Measuring risk 

Taking each of the categories of risk outlined in What are the risks of trading with CFD?It’s possible to grade each in terms of perceived likelihood of occurrence, and the degree of impact should it happen. As this risk measurement process should be something that is regularly carried out it’s even possible to itemize if the risk has been upgraded, downgraded or indeed hasnot changed since the last review.
Name Likelihood Impact Last Update
Market Risk High High Up
Concentration Risk Low Medium Up
Liquidity Risk Low High Up
Gapping Risk Medium High Up
Operational Risk Low Medium No Change
Client Money Risk Low Medium Down
Counterparty Risk Low Medium Down
(Could have a link to this to be a downloadable tool)

Managing Risk

Is your risk management policy asking the right questions and is it asking them in the right way? Consider these two questions:
    1. Have you completed your risk management report?
    2. How could you lose 5% of your capital today?
  The first question encourages a box ticking mentality; simply providing a ‘Yes’ means trading can start. The second question leads to more engagement andasks you to play devil’s advocate. Consider the number of once successful investment management firms that go bankrupt. The firms would have had systems and procedures that professional and dedicated staff adhered to, and yet they still went under. Good risk management is about more than just allocating enough time to convince yourself that it’s OK to get on with trading.