While profits are a possibility when trading or investing, many FX traders fail to effectively manage their risks, leading them to make mistakes. Here are some common pitfalls to avoid.
1. TRADING WITHOUT A STOP-LOSS
FX trading is done on a margin, which means that the investor only puts down a fraction of his total trade, with a broker providing the remainder. A margin of 5 per cent would require traders to place a S$5,000 deposit if they wish to trade S$100,000 in total.
However, margin trading can be very risky if a trade goes in the wrong direction. To limit losses, consider risk management tools like guaranteed stops and alerts.
Knock-Outs mitigate risk by allowing you to determine the exact price you would like your trade to get “knocked out” at the start by setting your Knock-Out level. The Knock-Out price moves one-to-one with the underlying price of the asset and you only pay for the stop if it is triggered. The Knock-Out level acts like a guarantee that closes out your trade even during times of huge market swings.
This ability to pre-determine your maximum loss level is especially critical during times of high volatility or when markets are closed, such as on weekends.
2. RISKING MORE THAN YOU CAN AFFORD
Some traders make the mistake of taking on more risk than they can afford.
To more effectively manage your risk, set a limit on how much you are prepared to lose on a trade. A Knock-Out lets you choose this limit by setting the Knock-Out level at the start of the process.
For instance, if you think the Wall Street Index is going to increase from its current level of 19,490, you can choose to buy a Bull Knock-Out, with a Knock-Out level of 19,290.
If you set the size of the trade at S$10, this means that your trade will move S$10 for every point that the index moves. If the premium is set at S$2, the maximum amount you can lose is calculated as follows:
[Size (10) X [Current Price (19,490) – Knock-Out Level (19,290)]] + Premium (2)] X Size (10) = S$2,020
Knock-Outs allow traders with different risk appetites and levels of experience to select their leverage depending on the risk they are comfortable taking.
3. NOT DOING YOUR HOMEWORK
As with any investment, you need to do your research to ensure you know what you’re getting into. FX is no different.
IG offers a raft of free educational materials, seminars and webinars to help you get familiar with FX trading.
4. PUTTING ALL YOUR EGGS IN ONE BASKET
What’s more, you can trade Knock-Outs on them which allows you to better manage your risk by giving you the liberty to choose the maximum losses you are willing to take at the start of the trading process.
5. BEING INFLUENCED BY MARKET EVENTS
With the onslaught of the 24-hour news cycle, many investors tend to let market events sway their emotions, resulting in bad investing decisions.
Using Knock-Outs can help prevent this because you won’t be able to change the Knock-Out level you set at the start. This eliminates the risk of you changing your mind and adjusting the stop-loss based on short-term market events.
6. ONLY TRADING IN ONE DIRECTION
Prices can go up or down, and it’s important to have a hedge to mitigate the risk if your trades are not going your way.
An advantage of trading CFD Knock-Out is that you can go long or short (buy or sell) during different market conditions.
For example, you can buy a Bull Knock-Out (long) if you are trading for the market to go up or buy a Bear Knock-Out (short) if you think the market will go down. This helps to limit your losses if your trades go south.