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TwitterTrading mistakes can be made by even the most skilled professionals. Most errors made by traders come about as a result of a insufficient preparation, data or control. Whilst it is important to learn from your mistakes, it is even better and far less expensive to learn from the mistakes of others.
Below are a few of the more common mistakes made by CFD traders:
1. Extreme Leverage.
One of many main benefits of CFD trading is the ability to gain exposure to a equity, index or currency contract with a comparatively small capital outlay. Instead of having to pay for the total notional value of the Contract for difference position CFD traders can enter into positions with margins as low as 5% or even less. One must always note that although a smaller capital outlay is necessary to open the position the CFD trader is still subjected to the price movement of the share CFD for the full notional worth of the position. A Contract for difference trader trading a Contract for difference at 5% margin is leveraging their initial expenditure by 20 times, meaning a $5,000 deposit might be used to open a $200,000 CFD position.
As only a fraction of the face-value of the trade is outlaid when trading CFDs a tiny price change may well result in sizeable gains but also sizeable losses. For example when trading a CFD with a margin of 5%, a price rise of 1% in the underlying instrument may result in gains of 20%, on the other hand, if the price fell by 1%, it might lead to a loss of 20% of the amount necessary to open the position.
You should keep in mind that gearing is often a double-edged sword not only can it work for you but when not managed properly it might also work against you, often amateur trades pay no attention to the fact that if unmanaged gearing can result in considerable losses.
2. Not understanding the impact of trade sizes on your account
Due to the gearing associated with Contract for difference trading, relatively small outlays can result in considerable moves within your overall account balance.
For instance buying 10,000 CFDs priced at $2.40 with a margin of 5% necessitates an outlay of only $1,200. With an outlay of only $1,200 it is possible to hold a $24,000 CFD position. Should the value of this position move one cent it will have an effect of $100 on the profit or loss on the traders account.
If the price of the this position increased by 12 cents a profit of $1,200 would have been made. However, if the value of the position fell by the same amount a loss of $1,200 would have been made.
The impact of any price movement will depend upon the traders overall account balance. For a trader with an account balance of $1,500, the aforementioned trade would have had a significant impact on the traders account profit and loss. Should a trader with an account balance of $40,000 take exactly the same position the effect would be much less significant.
A loss of $1,200 on a $1,500 account would lead to 80% of the entire account balance being lost. However, a loss of $1,200 on a $40,000 account would result in a loss of only 3% of the account balance.
3. Trading in too large parcels
You should calculate the exposure of your trade size ahead of placing the trade. It is not uncommon for novice CFD traders to simply trade the maximum size available to them according to their account balance without taking into account the amount of market exposure resulting from the position.
There are a number of strategies traders can adopt in order to work out position size. A simply strategy is to determine a suitable quantity of risk capital should the trade go against you and work out a suitable position size base on this.
In case you wish to restrict losses on any given trade to $200 you would calculate your position size according to your stop-loss price. For instance, if the CFD was priced at $1.40 and you stop-loss was at $1.15 your risk amount would be $0.25, to determine your position size you would basically divide the loss you’d be prepared to take by the risk amount. In this case this would be $200 / $0.25 = 800, as a result your position size ought to be 800 units.
The method outlined above is called fixed fractional position sizing in which a specific percentage of the overall account balance is risked on each trade. Other strategies include allocating a fixed dollar quantity to every trade, buying or selling a fixed quantity of CFDs in each trade or varying the size trades in accordance with the profitability of your account.
Using a position sizing approach may help you prevent the mistake of placing all your eggs in a single basket.
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