CFD Trading and Managing the Risks

For someone without previous experience, the art of trading CFDs can be somewhat intimidating. CFD trading requires a grasp of many unfamiliar concepts, not the least of which is using a CFD trading system. What exactly is that, and what separates the profitable CFD trading strategies from the rest? That’s what this article will tell you!

What is a CFD trading system?

Any trading system, whether it’s used to trade stocks, options, currencies, or CFDs, is nothing more than a set of criteria which determine when to enter and exit trading positions. A trading system for CFDs can either be completely mechanical, or partially mechanical and partially discretionary. Using a completely mechanical system will relieve you of having to do anything except stick to the pre-defined rules, while using a partially discretionary one will require you to spend a significant amount of time practice trading

If you’re smart, you’ll do your practice trading under the supervision of someone with experience trading that system, who can explain how to use the system’s rules most profitably.

Regardless of the sort of system you choose, you should make sure it has three absolutely essential features.

1. A stop-loss feature

A stop-loss feature will let you exit your CFD position as soon as it begins to go against you, minimizing the amount of damage. No smart investor ever puts money into a stock or CFD position without having an exit strategy. Without a stop loss in place, you will simply sit and watch helplessly as your trading float disappears.

The stop losses you use in your CFD trading should be set so that they won’t be triggered at the smallest downturn in a position price, nor to large so that the amount t of money you lose on your losing trades erases the profits on your winning ones. With some experience, you should be able to settle on acceptable, medium range stop losses.

2. A trailing stop-loss feature

A trailing stop-loss will simultaneously allow you to lock in a level of profit when a trade goes your way, and to remain in the position for as long as it is rising in price. As the price of the CFD increases, you can arias your trailing stop-loss to lock in even more profits, but have the security of knowing y will automatically be stopped out of your position when the price eventually falls (as it always will!)

A CFD trading system which has stop-loss and trailing stop-loss features will almost always ensure that your profits significantly exceed your losses, even though you may have far fewer winning than losing trades. And that’s the third feature which any good CFD trading strategy offers.

3. An acceptable profit-to-loss ratio

The profit to loss ratio is expressed in the formula average profit size/average loss size. If your average profit on your winning trade is $600, and your average los on your losing trade is $200m your profit-loss ratio will be 600/200, or 3.

You may also see the term win-loss ratio applied to different CFD systems. This term is expressed as percentage of winning trades/percentage of losing ones. If 40% of your trades (4 of every 10) make money, and 60% lose money, your CFD system’s win-loss ratio is 4/6, or .67.

To accurately judge the effectiveness of a CFD strategy, you really need to consider both its profit-loss and win-loss ratios together. Doing this will get you to a third term, the “profitability ratio.” The profitability ratio is calculated by multiplying the two, and if the answer is more than 1, the CFD system is a money-maker! In our example, the system would have a profitability ratio of 2 (3 x .67) and will, over the long term, be profitable.

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