The document provides information on risk management strategies for CFD traders. It discusses the importance of risk management, even when using strategies that have been successful. Specific risk management techniques are recommended, including: limiting the amount of capital devoted to trading; always using stop-loss orders to cut losses on every trade; and using fixed percentage position sizing to relate position size to a fixed percentage of account risk, such as 1-2% per trade. An example is provided to illustrate how to calculate position size using fixed percentage position sizing based on a trader's account size and initial stop-loss level. The document emphasizes that risk management is key to preserving capital and trading successfully over the long run.

1. the CMC Markets Trading Smart Series
Dealing with Risk

2. It is natural for new CFD traders to
concentrate on strategies to select
profitable positions but, while this is
essential, it is just as important to plan
how to deal with losses. The objective
of most traders is to make consistent
profits over the long term. However, it is
important to recognise that longer-term
trading inevitably involves losses too.
No one who trades for more than a short
period of time has 100% winning trades.
Proudly No. 1 for CFD education
Results from Investment Trends September 2010 Singapore
CFD Report, based on ratings given by 8,900 investors
CMC Markets | Dealing with Risk
2

3. Dealing with Risk
Appreciate the importance of gaining control over risk. Discover the methods of dealing with risk that are
within your grasp.
Finding the balance
Why risk management is important
CFD trading can be different to long-term investing in the way you
must deal with inevitable losses from time to time. After all, for an
investor it may be possible to avoid cash losses by holding assets such
as property or shares through bad times (often for many years) so the
price initially paid is eventually recovered.
It can be tempting to think that you can do without risk management
if you have successful trading strategies. Why bother placing limits on
your trading if you are using strategies that have worked in the past?
To succeed as a trader, the size of your potential losses needs to make
sense compared to the original profit potential on each new position.
Without a disciplined attitude to risk and reward, it is easy to fall into
the trap of holding losing positions for too long. Hoping things will turn
around before eventually closing out for a large loss makes no sense if
your original objective was a small profit over a few hours.
Experienced traders know that even strategies that have been
successful over the long term can leave you vulnerable to risks in the
short to medium term. These risks include:
•
significant runs of consecutive losses
•
o
ccasional large losses where prices gap through stop loss levels
due to a major news event
•
c
hanges in market circumstances which mean that you can never
be certain that just because a strategy has worked in the past it
will continue to work in the future
For traders, long-term profit comes from a winning combination of:
•
•
t
he number of profitable trades you have compared to the number
of losing trades AND
t
he average value of profits on each trade compared to the
average value of losses.
The combination of these ratios and the relationship between risk and
reward is the important thing. For example, many successful traders
actually have more losing than winning trades, but they make money
because the average size of each loss is much smaller than their
average profit. Others have a moderate average profit value compared
to losses but a relatively high percentage of winning positions.
Two keys to achieving a profitable combination of winning and losing
trades are:
1.
Successful strategies dealing with the what, when and why
of the positions you take.
This is sometimes referred to as your ‘trading edge’. It is important
that these strategies cover not only entering new trades, but also
getting out (in other words, when you will take profits and when
you will cut losses).
2. Following appropriate rules covering how much risk you will take.
These rules dealing with the question of ‘how much’ are usually
referred to as risk or money management.
In this guide, we discuss why risk management is important and
suggest six things to include in your own risk rules.
Without appropriate risk management, events like this can lead to:
•
loss of all your trading capital or more
•
losses that are too large given your overall financial position
•
h
aving to close positions in your account at just the wrong time
because you don’t have enough liquid funds available to cover
margin
•
t
he need for an extended period of profitable and prudent trading
just to recover your losses and restore your trading capital to its
original level
Loss taken
Gain necessary
10%
11%
15%
17%
25%
33%
30%
42%
50%
100%
75%
300%
90%
900%
CMC Markets | Dealing with Risk
3

4. Losing more than 30% of your CFD account can lead to a major
task just to recover what you have lost. After large losses, some
traders resort to taking even greater risks, and this can lead to everdeepening difficulties.
They again abandon their strategy, but this time by deciding not to
enter profitable positions that meet their trading rules. Often this
fear and excessive caution stems from the fact that traders are
taking too much risk.
For these reasons, risk management is essential to success even
with winning strategies. To get the benefit of a winning strategy over
the long term you need to be in a position to keep trading. With poor
risk management, the inevitable large market move or short-term
string of losses may bring your trading to a halt. You can’t avoid risk
as a trader, but you also need to preserve capital to make money.
A risk-managed approach to trading recognises that you are taking
risk but need to limit that risk in the short term to maximise longerterm opportunity. Lack of risk management is one the most common
reasons for failure.
Risk management involves limiting your positions so that if a big
market move or a large string of consecutive losses does happen,
your overall loss will be something you can reasonably afford. It also
aims to leave enough of your trading funds intact for you to recover
the losses through profitable trading within a reasonable timeframe.
The need for good risk management becomes all the more important
when you use leverage and don’t fully fund positions.
Using leverage and trading on margin can be a powerful tool. It
increases the opportunity for profit because you can often afford to
hold larger positions or a greater number of positions. It also has the
potential to increase your return on investment, because less capital
is needed to open and hold positions.
However, it is important to be aware that trading on margin is
a double-edged sword. It magnifies potential losses as well as
potential profits. This makes it even more important to limit your
exposure to large adverse market moves or larger-than-usual strings
of losses.
Good risk-management rules may seem to be holding you back at
times. They can have the effect of reducing your profits over the
short to medium term. There may be times when you are likely to
think: ‘I could have made more money if I wasn’t limiting my positions
because of risk management.’ This temptation to abandon prudent
risk management is often greatest after a period of success. A single
large trade in these circumstances can easily lose all your recent
hard-won profits and more.
This erratic position sizing can be another difficulty for traders
who don’t use risk management. It is all too common to have a lot
of successful trades with smaller positions only to find that the
inevitable losses comes along just when you have decided to take
on bigger positions.
The knowledge that your trading is backed by a good set of
risk-management rules can be a big help in avoiding the cycle of
euphoria and fear that often leads to poor decision-making. Good
risk management frees you to look at markets objectively and to go
with the flow of the market confident in the knowledge that you have
taken reasonable steps to limit the risk of large losses.
6 risk-management rules
1. Limit your trading capital
The first thing to decide is how much capital you will devote to
trading.
Many people are investors as well as traders. For example, you may
hold long-term assets such as shares or property. Trading normally
refers to buying and selling seeking to profit from relatively shortterm price changes. Investing, on the other hand, involves holding
assets to earn income and capital gain often over a relatively
long term. It can be a good idea to plan, fund and operate your
investment and trading separately, as each activity involves different
approaches to strategy and risk management.
The decision on how much capital to apply to trading is different for
every individual, but some of the factors you may wish to consider
include:
•
your overall financial situation and needs
•
your trading objectives
•
your tolerance for risk
•
your previous experience as an investor or trader.
A consistent, controlled approach to trading is more likely to be
successful in the long run. Gradually compounding your CFD account
by leaving your profits in the account and prudently increasing your
positions in line with your increased capital is a more likely path to
success than overtrading in the short term.
Wealth preservation should be a key consideration. It is best to limit
your trading capital to an amount that you could prudently afford to
lose if things go wrong. As previously discussed, this approach can
have the added benefit of allowing you to trade without feeling too
much pressure, and so improve your decision-making.
Good risk management can also improve the quality of your trading
decisions, by helping with your psychological approach to the market.
Getting into a cycle of overconfidence followed by excessive caution
is a common problem for traders. Trading without risk management
makes this more likely. When things are going well, it is easy to start
trading too much, abandoning strategy and taking large positions.
Then after large losses traders can understandably become fearful.
One useful technique in deciding on how much capital and risk to
allocate to trading is to conduct your own stress test. Calculate the
likely worst-case loss if there was a very big market move or a large
string of losses at a time you have your maximum position open.
Decide whether you could afford this and whether you could deal
with it emotionally. Limit your trading position to something you can
handle in these circumstances.
CMC Markets | Dealing with Risk
4

5. You should also make sure you have the liquid funds available to
support your planned trading activities. Even if you are comfortable
with the overall risk you take, it is best to make sure you have
enough funds in your CFD account, or available on short notice,
to support your trading activities at all times.
Finally, if you’re new to trading, it can be prudent to start in a
relatively small way and plan to increase your trading activities once
you have developed some experience and a track record of success.
2. Always use a stop loss order
Successful trading involves balancing risk and reward. Good traders
always work out where they will cut the loss on a trade before they
enter it.
slippage to occur on stop loss orders.
Slippage can also occur where there is not enough volume to fill your
stop order at the nominated price.
Even though stop loss orders can sometimes be subject to slippage,
they are a vital risk-management tool. It is good risk-management
practice to have a stop loss order in place for every position you
open. It is best to place the stop at the same time you enter the
trade.
The advantages of always using stop losses are:
•
Y
ou control your risk and reduce the chance of large unexpected
losses that can catch you off guard without a stop loss in place.
•
Y
ou are using a disciplined approach to trading. Placing a stop
order makes you consider where to cut losses before you enter
the trade. It also reduces the temptation to ‘run’ losses in the
hope of breaking even.
•
It helps you assess risk and reward.
•
Y
ou can measure the profit or loss achieved on each trade
against the original potential loss. This is the difference between
your entry price and the original stop price.
•
Y
ou may decide not to enter some trades if the profit potential is
too small compared to the initial risk.
•
I
t helps with time management. Stop losses are triggered
automatically, meaning you don’t have to be glued to the screen
monitoring your positions.
The CMC trading platform is specifically designed to assist you with
a risk reward approach to trading. It makes it easy to place a stop
loss order at the same time you open a new position.
Stop orders are used to exit positions after price moves against your
position.
A sell stop order is used if your opening trade was to buy and you
are long the market. A sell stop order can only be set at a level that
is below the current market price. If the market falls to the stop price
you nominate, the order becomes a market order to sell at the next
available price.
Stop orders are often called stop loss orders, but they can also be
used to take profits. For example, a common strategy is to move
your sell stop loss higher as the market moves higher. On the
CMC trading platform, this can be easily managed by applying the
trailing stop function.
A buy stop loss is used if your opening trade was to sell and you are
short the market. A buy stop order can only be placed above the
current market price. If the market rises to the stop price you have
nominated, the order becomes a market order to buy at the next
available price.
Slippage. It is important to know that stops may be filled at a worse
price than the level set in the order. Any difference between the
execution price and the stop level is known as slippage. The risk of
slippage means a stop loss cannot guarantee that your loss will be
limited to a certain amount.
One common reason for slippage is when price gaps in response to
a major news event. For example, you may set a stop loss at $10.00
on XYZ company CFDs when they are trading at $10.50. If XYZ
announces a profit downgrade and the price falls to $9.50 before
trading again, your stop will be triggered because the price had fallen
below $10.00. It then becomes a market order and is sold at the next
available price. If the first price at which your volume can be executed
is $9.48, your sell order would be executed at that price. In this case
you would suffer slippage of 52 cents per CFD.
Slippage is particularly common in shares because markets close
overnight. It is not at all uncommon for shares to open quite a bit
higher or lower than the previous day’s price, which makes it easy for
CMC Markets | Dealing with Risk
5

6. Resistance
Support
Moving average
Robyn has a strategy of entering trades when price bounces off
a moving average that coincides with support or resistance.
Quick position size example
Total account size
$10,000
In the Australia 200 index chart above, the moving average is at the
same level as the previous resistance, which now forms a potential
support level.
Risk 2% of total account
$200
Robyn’s strategy is to buy on the first close above the candle that
makes a low at the moving average. Her strategy calls for cutting
her loss if price falls below the support line, which is at 4111.5. She
wants to place a sell stop loss order at 4111.0.
Before Robyn confirms her entry order to buy at market, she sets the
stop loss order on the CMC trading platform at 4111.0. The stop level
appears as a red line on the chart.
The difference between
Australia 200 Index trading at
stop loss placed at
4500
4475
equals risk
25 points
$200.00 divided by
25
equals position size
8 units
Once Robyn confirms her buy order, the sell stop loss order will also
be automatically placed.
3. Use fixed percentage position sizing
Working out where to place stop losses is an important element of
your trading edge. One commonly used approach is to place stop
losses at the first place at which the strategy you are following can
be said to have failed.
In the example above, Robyn has bought based on a strategy of
entering when a correction rejects support and a moving average.
She then expects an uptrend to resume. If price falls below the
support line, the strategy can be said to have failed on this occasion.
Robyn places her initial sell stop loss at 4111.0, which is just under
the support line.
Fixed percentage position sizing involves calculating the position
size on each new trade so that the loss at the initial stop loss level
equals a fixed percentage of the funds in your CFD account, such as
1% or 2%.
For example, a trader with $10,000 in their CFD account might set the
size of each new position so that the loss at the initial stop loss is no
more that 2% of their capital, or $200.
In the example above, Robyn has a CFD account of $20,000
and uses 1% fixed position sizing. This means she manages her risk
so that if she is stopped out at 4111.0, the loss will be approximately
$200.
She sets her position at 11 points so that the loss at 4111 will be
approximately $200, in this case $207.90.
CMC Markets | Dealing with Risk
6

7. The CMC trading platform calculates the potential loss if price falls to
the stop level you set. Using fractional position sizing you can adjust
your position size even more precisely if you wish. You do not have
to trade in whole units.
Fixed percentage position sizing has a number of benefits:
•
It is a logical method of relating position size to risk.
•
Y
our positions automatically become smaller if you suffer losses
which helps to preserve your trading capital.
•
I
t avoids erratic position sizing and the risk of having big
positions when you lose but only small ones when you win.
•
I
t provides a method of gradually increasing your position size as
you make money. This can help your trading capital grow steadily
while maintaining the same percentage risk levels.
One of the things to consider in setting your position size
percentage is how much of your trading capital you would be
prepared to lose after a very large string of consecutive losses.
Using 1%, you would lose 13% of your capital after 14 consecutive
losses. Using 2%, you would lose 25% of your capital if you had 14
straight losses.
What % of trading capital should I apply in position sizing?
5
5%
6
6%
7
7%
8
8%
9
4
4%
6%
5
7%
6
9%
7
10%
8
11%
9%
9
10
10%
11
2
3
4
2%
4%
6%
8%
5
10%
6
11%
7
13%
8
15%
13%
9
10
14%
10%
11
12
11%
13
1
2
3
4
Drawdown
4%
3
3%
1
CONSECUTIVE LOSSES
4
3%
2
2%
2.5%
Drawdown
3
2%
1
CONSECUTIVE LOSSES
2
1%
2%
Drawdown
1
CONSECUTIVE LOSSES
1.5%
Drawdown
CONSECUTIVE LOSSES
1%
3%
5%
7%
10%
5
12%
6
14%
7
16%
8
18%
17%
9
20%
10
18%
10
22%
15%
11
20%
11
24%
12
17%
12
22%
12
26%
12%
13
18%
13
23%
13
28%
14
13%
14
19%
14
25%
14
30%
15
14%
15
20%
15
26%
15
32%
16
15%
16
21%
16
28%
16
33%
17
16%
17
23%
17
29%
17
35%
18
17%
18
24%
18
30%
18
37%
19
17%
19
25%
19
32%
19
38%
20
18%
20
26%
20
33%
20
40%
21
19%
21
27%
21
35%
21
41%
22
20%
22
28%
22
36%
22
43%
4. Set an upper limit on the number or value
of positions you have open at any one time
This rule aims to defend your trading capital if you have positions
open when there is a single adverse market event.
For example, a trader using fixed percentage position sizing of 1.5%
may set themselves a rule that they will not have more than 10 or
perhaps 15 positions open at any one time. Assuming there is no
slippage, this means their loss would be no more than 15% or 22.5%
of their trading capital if they lost on all the positions. It’s up to you
to set the limit that you feel is appropriate for your circumstances
and trading.
As discussed, company CFDs can be more vulnerable than other
markets to gapping through stop loss levels because they close
overnight. To manage this risk, it can pay to have a limit on the value
of the total of the net long or short company CFD positions you hold
at one time.
CMC Markets | Dealing with Risk
7

8. For example, if you limit the total value of net long company CFD
positions to 300% of the funds in your account, then a 7% overnight
decline on all the positions would limit your loss to 21% of the funds
in your account. A limit of 200% mean you lose 20% of your account
if all the positions fell by 10% overnight.
•
C
ompany CFDs in a single industry and listed on the same
exchange, for example, Australian bank shares
•
C
losely related commodities, for example, wheat, corn
and soybean
5. Set an upper limit on the number of positions
you have open in closely related instruments
6. Set an upper limit on total losses from
a single strategy
Diversification is just as important for traders as it is for investors. It
is important not to have all your eggs in one basket.
Many traders will use different trading strategies. It pays to draw
the line on a single set of trading rules if it loses too much of your
capital.
You may consider having no more than two positions net long or
short in closely related instruments. Net long refers to the difference
between your total long and total short positions, for example, six
long and four short positions means you are net long two positions.
Examples of closely related instruments would include:
•
Foreign exchange pairs involving the same currency, for example,
• EUR/USD
• GBP/USD
• USD/JPY
One useful approach can be to set smaller limits for new strategies,
but to be more tolerant with a proven strategy that you have used
successfully over a long period of time and where you are familiar
with its risk history, including likely number of consecutive losses
and stop loss slippage.
• USD/CHF
• AUD/USD
Self assessment
Please give some thought to the following questions and take
the time to calculate answers:
1.
How much is your trading capital?
2. it better that your risk is greater than your reward? After
Is
8 winning and 2 losing trades with $50 reward and $250 risk,
would you be ahead?
3.
Position sizing calculation …
i.
using as a risk-management example the two percent rule,
and assuming trading capital of $5,000, calculate 2% of
trading capital =
ii.
with a position at $10.20 and a stop loss at $9.95, your risk
will be =
iii.
the number of CFDs to buy (position size) will be i divided
by ii =
CMC Markets | Dealing with Risk
8

9. The information contained herein / presentation (the “Information”) is provided strictly for informational purposes only and must not be reproduced, distributed
or given to any person without the express permission of CMC Markets Singapore Pte. Ltd. (“CMC Markets”).
The Information is not to be regarded as an offer, a solicitation or an invitation to deal in any investment product or an advice or a recommendation with respect
to any investment product, and does not have regard to the specific investment objectives, financial situation and particular needs of any specific person.
Contracts for Difference and leveraged foreign exchange trading involve the risk of sustaining substantial losses and are not suitable for all investors. You should
independently consider the Information in the light of your investment objectives, financial situation and particular needs and, where necessary, consult an independent financial adviser before dealing in any investment product. Risk warning/disclosures and other important information are available at our website: www.
cmcmarkets.com.sg or by contacting us at + (65) 6559 6000.
CMC Markets does not warrant the accuracy, completeness, suitability, currency or reliability of the Information. CMC Markets accepts no liability for loss whatsoever arising from or in connection with the use of or reliance on the Information. It should not be assumed that any product evaluation or analysis techniques
presented herein, if relied upon, will guarantee profits or gains or will not lead to losses. Any graph, chart or any device set out or referred to herein / presentation
possesses inherent limitations and practical difficulties with respect to its use, and cannot, in and of itself, be used to assist any person to determine and/or to
decide which investment product to buy or sell, or when to buy or sell them. Past performance is not necessarily indicative of future performance, result or trend.
CMC Markets does not and shall not be deemed, and accepts no obligation, to provide advice or recommendation of any sort in relation to any investment product. CMC Markets may or may have expressed views different from the Information and all views expressed are subject to change without notice. CMC Markets
reserves the right to act upon or use the Information at any time, including before its publication herein.
CMC Markets Singapore Pte. Ltd.
50 Raffles Place #14-06
Singapore Land Tower
Singapore 048623
T
T
F
E
1800 559 6000 (local)
+65 6559 6000 (international)
+65 6559 6099
sales@cmcmarkets.com.sg
cmcmarkets.com.sg
© CMC Markets Singapore Pte. Ltd., Reg. No./UEN 200605050E. All rights reserved December 2011.