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There are two types of investors—those who watch every movement of the markets with their hearts in their mouths, and those who just want to grow their money passively.
If you fall into the second category, risk management might seem like something that’s irrelevant to you, and that only expert investors need to worry about. You might imagine investors poring over complicated systems or engaging in rocket science-level analysis in order to properly manage risk.
But risk management is actually something ALL investors, not just experts, should put some effort into.
Furthermore, with the recent increase in margin requirements for FX traders, investors will feel a greater need to properly manage their risk.
The good news is that thanks to technology, you now have access to a variety of simple tools that can help you manage risk in an easy yet effective way.
Impact of margin increases on FX traders
MAS recently raised the minimum margin for FX traders from 2% to 5% (these rules do not apply to accredited and expert investors).
What this means is that traders now need to put up a larger proportion of their trades in cash when they are trading on margin. We’ve covered the impact of the margin increase in greater detail here.
The new rule means you now need to put up more cash to make trades of the same size as before when margin trading FX. This has the effect of limiting trade sizes, and also making investors run out of cash faster, which hampers their ability to ride out losses.
The result is that investors will need to mitigate risk even more carefully to ensure they limit their losses.
What can traders do to better mitigate risk?
Platforms like IG offer a range of tools that enable traders to mitigate risk. Risk management is really not as complicated as it sounds. Here are three tips.
1) Set up a system to help with trading discipline
Setting up a trading system like algorithmic trading is essential to help you be consistent in your trades and avoid being swayed by emotion.
Your system should help you identify when to enter the market and when to exit in order to minimise losses.
Once you have identified these parameters, you can simply set alerts that inform you when action is needed on your part.
Algorithmic trading or automated trading enables you to pre-programme parameters such as price, volume and time, letting you trade without having to constantly monitor the markets. It offers a way to remove human error, keep your trades unaffected by emotions and save time.
2) Set hard thresholds to close positions
A big part of risk management is ensuring that you close positions in time. Many online trading platforms enable you to automatically close positions when they reach pre-set thresholds (aka when your stop is hit). One way to do that is by using guaranteed stops. You simply pre-define a price, and your trade will close once it is reached. This ensures that your losses do not exceed a certain amount as defined by your guaranteed stop.
You can also consider IG’s latest limited-risk product, Knock-outs, which enables you to customise your CFD trades by indicating your desired knock-out price (something like a G-stop). You buy bull knock-outs if you think the market will rise and bear knock-outs if you predict a fall in the market. If the market moves in the opposite direction from what you have predicted, your trade will automatically close when your knock-out level is reached.
The biggest advantage of this product is that you know the maximum loss you can make when you first place your trade, and can set the maximum risk you are comfortable with. Because of that, you can’t lose more than the initial margin that you pay when you set up your knock-out trade.
3) Understand the asset class you are trading
As a trader, you should become familiar with the particular asset classes you are working with in order to know how best to mitigate risks. Using tried and tested strategies can help newbie traders, but in the long run you will benefit from having an intimate knowledge of the assets you are trading.
To get a head start in understanding different asset classes like indices, gold and silver, download IG’s guide written in partnership with Bloomberg – Alternatives to FX CFD trading.
To limit risk on your CFD trades, check out IG’s new feature Knock-outs, which helps you manage your risk so you no longer need to constantly monitor the markets or stress out about market volatility. Find out more about IG Knock-outs here.
Do you have any questions about risk management? Ask away in the comments!
This advertisement has not been reviewed by the MAS. The information in this article is meant for informational purposes only and should not be relied upon as financial advice. Users may wish to approach a financial advisor before relying on any advice provided by the website to make any decision to buy, sell or hold any investment product. Contracts for Difference (CFDs) are speculative products. The leveraged nature of CFDs involves the risk of losing substantially more than your initial investment.