The first question is what does risk management mean in the trading industry? This is best described as the method you would use to safeguard your trades in the financial markets.
The second question is: why is it important in trading? Risk management helps you define future objectives and minimise losses. If objectives are defined without risk consideration, sudden price moves could take you by surprise and disrupt your trading strategy.
A successful risk management strategy is fundamental to protecting your trading profits. If you keep losing money, you will eventually become discouraged and stop trading.
There are numerous techniques you can use to read price movements in the financial markets. These will go a long way in helping to ensure that you’re able to continue trading the markets.
What is leveraged trading?
Leveraged trading means you can trade using margin. This is to say that with certain forms of trading, you can open a position by depositing just a percentage of the full value of your trade.
Learning CFD trading and spread betting are two examples of leveraged financial trading. This is in contrast with more conventional forms of trading, such as share trading. In its simplest form, when you trade shares, you would have to deposit the full value of your trade to open your position.
Trading using margin or leverage can magnify your gains. The key risk of leverage, however, is that it can also magnify your losses in the exact same way.
Common types of trading
There are various forms of financial trading for you to choose from, depending on your trading strategy. These include spread betting, CFD trading and share dealing.
Spread betting
Spread betting is offered only in the UK and Ireland. It is a leveraged product that enables you to profit from fluctuations in the price of a financial asset. You can take a position on hundreds of financial instruments across numerous asset classes. These include forex, commodities, indices, as well as thousands of global shares.
With spread betting, you can speculate on rising as well as falling market prices. When you think the price of an instrument will rise, you buy. If you think it will fall, you sell.
CFD trading
Like spread betting, contracts for difference (CFD) allow you to trade the markets by depositing a small portion of the total trade value. Your profit or loss is determined by the difference between the price at which you enter and exit a trade, multiplied by the number of units you have bought.
Share trading
A stock (also known as share) market is a secondary market, where you can buy or sell shares.
When you buy a share on the stock market, you are buying it from another existing shareholder. Likewise, when you sell your shares, it is not back to the company – but to another investor.
Most forms of trading are now available online. You can trade shares, currencies, commodities, CFDs as well as spread bet online using a trading platform.
How do stop losses work?
A standard stop loss closes a losing trade after the market passes a pre-defined trigger value set by the trader. This helps you to reduce losses and safeguard against risks. This method is not always foolproof, however. During times of market volatility, your trade could be closed at a level that is worse than your trigger value. This happens because prices can sometimes jump from one level to the next, without actually passing through the level in between. This is known as ‘market gapping’.
Some traders prefer to opt for a guaranteed stop-loss order (GSLO) to protect their trades against gapping. Working in the same way as a standard stop loss, GSLOs guarantee to close your trade at the trigger value you have set. This extra security is not always available on all markets, and comes at an additional cost.
What is a take-profit order?
This is about understanding how to exit the market when it is appropriate. A take-profit order closes your trade once it reaches a certain level of profit as defined by you. A take-profit order used in combination with a stop loss can help you to define your risk:reward ratio.
Using a risk:reward ratio
Using a risk:reward ratio can help you strengthen your trading strategy. It can compare the expected returns of an investment to the amount of risk undertaken.
To be considered useful, a risk:reward ratio should be used with a take-profit order. It should take the monetary value from each trade into account to offer a proper assessment of your portfolio.
