Basic Principles of CFD Trading 3 Contracts For Difference 3 Leverage and Margin 3 Spreads 4 Pip Calculation 4 Rollover Fees 5 Expiration Dates6II. Risks Involved in Trading. 6 Losses 6 Margin Call and Stop Out 7 Market Volatility 8 Slippage9III. Risk Management Tools 10 Equity Drop Alert 10 Stop Loss Orders 11 Take Profit 13 Manual Closure of Trades14Conclusion153
This risk management guide’s purpose is to alert and explain the main risks trading online may pose to new traders over the course of their trading career. Even if you have experience in trading leveraged products, we strongly suggest that you carefully read this guide.
The goal of this guide is to ensure traders are supplied with a sound foundation of trading information in order to understand the importance of building a robust Risk Management Plan as a fundamental prerequisite of a successful trading career.
This applies to all traders, both new and experienced.By having a solid understanding of the risks involved in trading and being aware of the trading tools available, traders can enhance their ability to minimise exposure to risks.
Risk management is essential to the success of any trader. Success may be defined as the point where trades return more profits than losses. As such, it is crucial that as a trader you realise that potential losses are as integral and important a part of trading as potential profits. A correct approach to risk management attributes equal importance to both of these fundamental aspects.
Developing a personal trading strategy is crucial to every trader’s success. It is of particular importance for you to develop a unique trading and risk management strategy of your own, as any decisions and actions you take regarding trading are your sole and absolute responsibility.
As a consequence, you will also be fully responsible for the results of your trading decisions and actions, whether they be profits or losses. As such, you should not underestimate the importance of having a solid understanding of the principles, risks, and tools presented in this guide.
The following section will present the fundamental principles of CFD trading. Comprehensive knowledge of these principles is necessary to understand the risk factors you may be exposed to while trading.
A more in-depth analysis of these specific risk factors will be presented in the second section of this guide. Finally, the third section will focus on the tools available for managing the risks.I.
The Basic Principles of CFD TradingA solid grasp of the fundamental principles of CFD trading is crucial for managing your risk.
The next section of this guide will present you with a variety of different forms of risk that should serve as the basis for every trader’s risk management plan.Contracts For DifferenceA contract for difference (CFD) is a derivative financial instrument with an underlying asset, meaning you do not physically own the underlying asset.
A CFD is an agreement between the buyer and seller to exchange the difference in the current value of the underlying asset, such as a share, currency, commodity, or index and its value at the end of the contract.
As derivatives, the price levels of CFDs are directly related to those of their underlying assets, and are thus affected by market volatility in the underlying instrument market.
Please refer to the below section on Market Volatility for more information.Leverage and MarginCFDs are a leveraged product, which means that you only need to deposit a small percentage of the full value of the trade in order to open a position.
You are able to leverage your investment by opening positions of a larger size than the funds you have in your account. This is called “trading on margin” (or margin requirement).
4With leverage you are investing a fraction of the trade’s value, but your position will return profits and losses as if you had invested the full value of the CFD position. It is crucial that you understand that leverage will inflate both your profits and losses.
For an example of how leverage affects profits and losses, please see the section below on Losses. Leverage is expressed as a ratio of X:1 where X is the leverage.
Most currencies have a leverage of 400:1, so we can say that the leverage is 400. Stocks usually have a lower leverage of 20:1 so the leverage is 20.The margin requirement is directly related to leverage.
It is the expression in percentage of the leverage ratio. A leverage of 20 means a margin requirement of 5% (20:1 = 1/20 = (1/20 × 100) % = 100/20 % = 5 %)For example:You decide to buy 4000 CFDs of Share A at the price of $10 per CFD. Your position is therefore $40,000 (4000 x $10).You will not actually pay $40,000: the amount you will pay depends on the margin required by the CFD.
If the CFD trades with a leverage of 20 (margin requirement of 5%) the required margin would be calculated as follows:a) (Amount x price)/leverage4000 x $10/20 = 2000$ORb) (Amount x price) x margin requirement %40000 x $10 x 5% = $2000This means that your minimum initial payment is $2000 instead of $40,000.
You require an initial balance (margin) of $2000 in your account to open this trade.SpreadsThe “Bid/Ask Spread” is the difference between the Bid and the Ask prices available for each asset.
\Whenever you open a trade, you will start with a loss. That loss amount is the spread, and will appear automatically on every trade you open.If you open trades worth a large percentage of your equity, the initial loss due to the spread may bring your account balance dangerously close to Stop Out levels.
To avoid such situations, you should be aware of the spread amount you will have to pay before opening the trade and refrain from trading in volumes which are too risky for your account’s balance.
You can calculate the value of the spread by calculating the value of the pips, as shown in the section below. Each asset has a different spread which is published on our website.
You can also find the spread of each asset on our platform and are strongly encouraged to study the lists. Before opening a position, you should bear the spread of the asset in mind.
You can also read more on how the Spread works in our Best Execution Policy.5Pip CalculationCalculating the pip value of your trades is a fundamental principle of managing your risk exposure and can give you better control over your trades.
Once you have calculated the value of the pip, you will be able to know the impact (in terms of profit or loss) of any price fluctuations in the market.The formula for pip calculation is as follows:For currencyPip Value = (Pip in decimal places * Trade Size) 10Example: Trading 100,000 of the pair EUR/USD.One pip in decimals = 0.0001Trade Size = 100,0000.0001 * 100,000 = 10Each pip is worth $10If the account currency is not the same as the second currency in the pair (i.e., for any pair that is not XXX/USD), you will need to divide the value of the pip by the exchange rate, so the value will be in U.S. dollars.
In this case the calculation is as follows:(Pip in decimal places * Trade Size)/Market PriceExample: Buying 100,000 of the pair AUD/CAD One pip in decimals = 0.0001Trade Size = 100,0000.0001 * 100,000 = 10Pip value = 10USD/CAD price: 1.2913110/1.29131 = 7.7440Each pip is worth $7.74Rollover FeesUFX does not charge a rolling commission. What we do charge is a rollover fee (also known as an overnight swap).
The rollover fee is calculated when a trader leaves a position open past 00:00 GMT.The term “rollover” refers to the interest rate that traders will pay, or receive, on the open positions that are rolled over from one day to the next. Every currency pair has its own interest rate.
At the end of every trading day, at 00:00 GMT, the trader will pay or receive the interest rate on the currency pairs they hold.In the trading market, interest is calculated on a daily basis.
At the end of each trading day, at 00:00 GMT, traders can see from their account statement if they were charged or received the rollover fee. On regular weekdays, the rollover rate is charged for the previous trading day. As the trading week has five days, on Wednesdays, rollover interest for the next weekend is charged for three days.
The following is a brief explanation of rollover interest:The interest rate of the main currency is lower than that of the secondary currency.For Example: EUR/AUD. EUR – Interest rate of 1.25%; AUD – interest rate of 4.50%The Euro is the main currency of the pair and its interest rate is lower than that of the secondary currency, which is the Australian Dollar (AUD).Buy/Long:
When the Trader buys the Euro, he will be charged the rollover fee.Sell/Short: When the Trader sells the Euro, he will receive the rollover fee.NOTE: Trade volumes affect the amount of the rollover fee; the larger the volume traded, the larger 6the rollover fee.Rollover fees are charged as follows: From Sunday night to Monday: regular rollover fee From Monday night to Tuesday: regular rollover feeFrom Tuesday night to Wednesday: regular rollover feeFrom Wednesday night to Thursday: rollover fee is charged three times (for Wednesday, Friday, and Saturday) From Thursday night to Friday: regular rollover feeIn very specific situations, namely when your balance is very low, if you allow Rollover fees to add up, this might drop your balance below the Stop Out level and thus trigger a Stop Out.Expiration DatesSome underlying assets have contracts with a limited lifetime and a specific expiration date.
As such, it is strongly recommended that you refer to our website’s up-to-date list with the expiration dates of underlying assets. When the expiration date is reached all open deals based on that asset will be closed automatically at the market rate of the expiration date. This means that, depending on the market rate, your trades may close with a profit or a loss.As such, it is very important that you make yourself aware of the expiry dates before opening a trade so you are not surprised by an unexpected closure and the unexpected consequences such an event may generate. Being aware of the time frame within which you will be able to trade a certain asset before you initiate the trade is a basic but extremely important factor in managing your risks.
Being aware of the time frame and expiration date of any contract in a specific asset is your sole responsibility as a trader.Expiration dates for all assets are available on our website athttps://www.ufx.com/en-GB/assets/asset-expirations/and can also be obtained by contacting our Customer Support team.The expiration date of your trade will also be displayed on the trading platform after you have opened a position, but you should be aware of this date before opening any trade.
Armed with an in-depth understanding of all the fundamental principles discussed in this section, you should be better prepared to develop your risk management strategy for the risks described in the second part of this guide.II. Risks Involved in TradingAs a new trader, it is imperative for you to understand the risks associated with trading leveraged products. Risk can be generally defined as the possibility of an investment unexpectedly returning a financial loss as opposed to a profit.
Risk can be calculated based on the likelihood of the unexpected outcome occurring and the amount such a loss would represent if it occurs.The focus of this section is on the specific risks you will need to manage, along with an in-depth description of their nature, characteristics, and consequences.
At the end of this section, you should have a firm understanding of how to structure your risk management strategies around the risks described. 7LossesAs leveraged instruments, CFDs have the potential to generate both significant profits and losses. Moreover, leverage increases the speed at which profits and losses can occur, and may leave traders with relatively little time to react to asset volatility.To illustrate the effect of leverage on profits and losses, please consider the example of 4000 shares with 20:1 leverage used in the “Le verage and Margin” section above.In this case, if share prices fall by 1% (to $9.9) this would translate to -20% (-$400) of your investment as a result of 20:1 leverage.
Conversely, a rise of 1% in share prices (+$10.10) would translate to a profit of 20% on your investment (+$400).With a leverage rate of 20, a movement of 5% on the price of the CFD can mean a 100% profit or 100% loss (in this case, a profit of $2000 or a loss of $2000). If the price moves more than 5%, you could see a return on your investment that exceeds +/-100%.As shown in the example above, it is absolutely necessary for you to understand that your exposure to the market will always equal the full value of the underlying shares of the CFD you are trading on.
Therefore, when trading with leverage, your profits and losses are also calculated based on the underlying value.In other words, you may profit or lose a much greater amount than the value of your initial margin investment, up to the full balance of your account.Because leverage influences the speed at which profits and losses can be made, it is of the utmost importance to monitor your open positions closely. It is your responsibility to monitor your trades and ensure you will be able to monitor all open positions until they are closed.Margin Call and Stop OutA Stop Out occurs when all open positions in your account are automatically closed because your account margin dropped below certain levels of equity.
This usually means that you have lost all or nearly all your account balance. At margin levels of less than 25% of your equity, we reserve the discretionary right to close all your open positions immediately and without notice.A Stop Out can occur when your open positions are incurring losses, particularly those involving underlying assets experiencing high market volatility.
Trading highly volatile assets can cause the balance of your account to drop rapidly to unsustainable levels. If you are not closely monitoring the state of your account and you do not have sufficient funds to cover these situations, you run the risk of all your open positions being automatically closed if the balance of your account falls below the Stop Out level (as shown on the platform).You should always be conscious of the size of your positions relative to the funds available in your account and refrain from opening high-volume trades which your account cannot sustain. When you open large trades without the appropriate level of funds in your account to sustain them, even small price changes can drop your margin below the Stop Out level.
If you decide that this is an acceptable risk, in light of the profits you may generate with such a high-risk trading approach, you will have to continuously monitor your account and be prepared to deposit additional funds or close your positions (or a portion of your positions), as necessary, to maintain a sufficient level of funds in the account so as to prevent a Stop Out.