Managing trading risk

No trading strategy has a 100% win rate. That’s why it’s important that you learn how to manage your risk and protect your profits. In this lesson, we’ll explore the key risks of trading and the ways you can mitigate them.

• What are the risks of trading?
• How to manage trading risk
• Prepare, prepare and prepare some more
• Use stop-loss orders
• Diversify your portfolio
• How City Index helps manage risk

What are the risks of trading?

The risks of trading are considered part and parcel of the whole experience. Everyone knows that markets rise and fall. It’s what makes trading exciting and creates opportunity.

But it’s also what can lead to losses. And sometimes, big losses.

Let’s go over a few of the most common risks that traders face:

• Market volatility

  Financial markets can react quickly and dramatically to a wide range of events – including everything from interest rate decisions to company earnings – and while that volatility can produce trading opportunities, it also increases risk. When markets move quickly, losses can stack up fast
  
  

• Slippage

  Every time you execute a trade, there’s the risk that the price you’ve asked for isn’t the price you’re given. As markets move quickly, prices can change in the seconds between when you place your order and when it’s executed. Although these differences are small, they can stack up over time. Slippage can both positively and negatively impact your position, but in this lesson, we’re just focused on the latter situation
  
  

• Leverage

  Trading on leverage means that from a small initial capital outlay you’ll get a full market exposure. As a result, gains are magnified. However, so are losses – including the potential you’ll lose more than your initial deposit. This makes learning about leverage vital, which you can do in our course for beginners
  
  

• Gapping

  When a market gaps, there is a sudden and dramatic difference between two prices. This most commonly occurs overnight – creating a gap between the previous close and the current day’s open. This can turn what you thought was a winning trade last night into a loser in the blink of an eye

How to manage trading risk

Your trading strategy can go some way to mitigating your risks. For example, day trading is a popular way to avoid the risk of gapping, while position trading isn’t concerned with the smaller movements of volatile markets anyway.

But there’s no such thing as a perfect strategy. All you can do is learn about the risks you might face and manage them as best you can.

Managing risk isn’t a “one and done” process. You’ll constantly be tweaking and adding to your risk management toolbox as you learn more about what suits you and your strategy.

Here are a few helpful tips to get you started.

Prepare, prepare and prepare some more

Research is one of the most overlooked ways of managing risk. Being caught unawares by a market-moving event can quickly turn a winning trade into a losing one.

To help you stay on the pulse of these events, we’ve got some useful trading tools available.

• Economic calendar – this lists the dates of major events and statements, including central bank decisions, economic data and public holidays
• Company announcements – knowing when a company is releasing its financials is vital if you focus on shares
• SMS price alerts – we’ll send you notifications of key markets and your trigger prices to help you stay in touch with the markets, without having to monitor them constantly

Use stop-loss orders

A stop loss will automatically close a trade if the price falls below a level chosen by you.

This means you don't need to constantly monitor your positions, and it prevents you from being tempted to let your losses run.

You set a price, and should the market price fall below it, the trade is closed automatically.

Stop losses are free to add to your position. On the deal ticket, you simply select the stop loss box and enter your desired price. Should you forget to add a stop loss, you can always attach one once the trade has been opened.

Beware: as we’ve already seen, it’s not always guaranteed that your stop loss will close at your chosen price due to slippage and gapping risk. If this happens your stop loss will execute at the next best available price.

If you want the assurance that your trade will be closed at the prescribed level, you can use a guaranteed stop loss. They’re free to attach, but you’ll be charged if they’re triggered. They do, however, guard against slippage.

Another alternative is a trailing stop loss. This ‘trails’ your position by a certain number of points. It’s great for ensuring that you lock in profits if the market moves in your favour but closes your trade if the market moves against you.

Want to know more about each order type? See our introduction to trading course.

Diversify your portfolio

This is the traders’ equivalent of ‘don’t put all your eggs in one basket’.

Spreading capital out across different sectors, asset types and geographies is one of the most important ways of addressing your market risk. The idea is that if one of your positions starts to make a loss, all your capital won’t be wiped out at once because other positions will still be in profit.

The best way to diversify is to look at which markets are correlated. For example, if you wanted to manage risk on your gold position, then you probably wouldn’t choose the Australian Dollar, which traditionally has a positive relationship with the metal. Instead, you might look at the US Dollar or stocks, which tend to rise when gold prices fall and vice versa.

How City Index helps manage risk

As well as a range of stops and limit orders available, there are two additional ways that City Index helps manage your risk.

1. Limited-risk trading

   We offer the ability to limit your risk by setting a guaranteed closeout level on your trades. To do so, you can either trade using guaranteed stop losses, available on thousands of markets, or by trading Knockout Options, which provide an exciting, innovative and simple way to trade a range of major FX, indices and commodities markets. Both products have the added benefit of lowering your margin requirement on the trade. You can access both these limited-risk products in the trading platform.
   
   

2. Automated margin closeout

   Your trading account has a pre-set margin closeout level, set at 50% of your margin requirement. If the net equity on your account hits this, our system will begin to close out one or more of your open positions (in order of largest losing position first) at the first available price, until your margin level indicator returns above 50%. This may take precedence over any pre-existing instructions you’ve set, and is designed to prevent you from incurring heavy losses when markets move against you.