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FXGT
Date:
24th Jul 2020
Author:
FXGT

STOP! Most Frequently Made Mistakes in CFD Trading

Contracts for Difference (CFDs) are versatile financial instruments that help hedge against market risks, both in forex and crypto trading. These derivative instruments offer the flexibility to take positions in both rising and falling markets. Regulated forex brokers with high leverage on offer allow traders to efficiently gain large exposure to market movements.

However, leveraged forex trading through CFDs or any other instrument does include its own share of risks. High market volatility can lead to magnified losses, when the markets move in the opposite direction.

To avoid sizeable losses, or missing out on trading opportunities, it is vital to take a considered approach to CFD trading. Here are some common mistakes that may lead to a significant erosion of capital during trading.
 
Apart from forex and crypto, CFDs allow traders to assume positions in various other asset classes, including commodities, stocks and indices. However, just because you have access to hundreds of assets, doesn’t mean you should be trading them all.

Traders need to understand the nature of the financial markets and then pick a few to familiarise themselves with and follow on a daily basis. Here are some important questions to address when selecting which markets to follow:
  • How volatile is the market?
  • How does the market function?
  • Is it an OTC or exchange market?
  • Does it suit your trading style and hours?
  • Do you have access to a robust trading platform to counter the volatility?
  • What knowledge do you already have of this particular market?

Without proper research, traders are unlikely to be equipped with the knowledge or skill to deal with or be prepared for risks. This is why beginners prefers to start trading in stable and liquid markets, like forex, as they figure out the intricacies of CFD trading.
 
An important psychological element to long term trading success is understanding your risk appetite. Every trader has a different level of risk tolerance, which essentially means the amount that they can afford to lose on a single trade. It is important to understand this level, in order to deploy appropriate risk management strategies.

The reality is that even the most successful traders don’t earn profits 100% of the times. The reason they are successful is that they understand the amount of risk they are capable of bearing. Calculating the risk/reward ratio of a trade helps traders determine the potential for earning from a specific trade, as compared to the level of risk they would undertake. The key is to enter trades where the potential to gain exceeds the potential for losses.

For instance, your analysis reveals that you have the potential to earn $5 if the market goes in your favour, while you could lose $3 if the market goes against your prediction. Here, the potential return is greater than the potential risk, so it appears a viable position to enter.

It is a good idea for new traders to calculate the risk/reward ratio before entering a trade and placing the stop loss and take profit levels accordingly. If the risk is higher than the expected return, it may be best to wait for the next trading opportunity. Successful traders recommend risking only 1% to 2% of their trading capital on a single trade.
 
Without a strategy, long term success in the financial markets isn’t possible. Traders must have a defined trading plan by answering key questions:
  • Which markets to invest in?
  • What kind of trading style to follow: scalping, swing trading, news trading What will be the entry and exit points?
  • Where should the stop-loss be placed?
  • What is the profit target?

It is equally important to stick to the plan, even if you fail to achieve the desired results a few times. A bad trading day doesn’t mean that the strategy is flawed.
 
Sometimes the markets do not throw up good opportunities. At such times, sitting on the side lines and waiting for a clear trend to emerge is a completely sound strategy. It is a mistake to think that CFD positions must always be active for a successful trading experience. Similarly, letting losing positions run for too long, in hopes of the market reversing soon, could be also be a bad decision.

Each trade should be considered after careful analysis of predefined risk parametres and based on its own merits.

CFD trading could be a great way to enter the forex and crypto markets. It offers the ability to trade both rising and falling markets, without needing to physically own the underlying asset. This means that you can start trading with a small capital and gradually increase your position sizes as you gain familiarity with and knowledge of the market. Also, remember to choose a regulated broker, who will be committed to protecting your interests and providing rich educational resources to enhance your trading journey.
 
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