In CFD trading, risk management refers to determining how much funds are to be put into each trade to make sure that you will easily survive losing trade and will be able to go on with trading in order to get returns. To understand it more clearly, let’s take an imaginary trading system as an example. Say in your system you may have found that during backtesting, your system generates x% return, a maximum drawdown of y%, and highest losing trades in a row of z.

Assuming that your system is performing, if you follow the trading system with same set risk management rules, this is expected to generate the same kind of output in real trading. And if you face a year that has come up with y% drawdown, or z losing trades in a row, then the right risk management will help you to survive in the drawdown and get a return for that particular period.

Going for CFD trading without proper risk management can expose you to unnecessary risk. For example, if you put a considerable portion of your float into each trade without using risk management, this can cost you all the float and you can discover that you are no longer in a position to continue trading, means your trades are not going to generate any profit for you. This can force you out of the market that definitely you don’t want to see.

Now we will have a look at the fixed dollar trade size model; a very common risk management method so that you can have some idea about how the money management works in trading. There are many other risk management methods available out there. But as an illustration, here we will give focus on this particular method.

CFD Position Sizing: Fixed Dollar Trade Size Model

Let’s have a look at how to consider CFD position sizing when you are trading CFDs. For this CFD risk management model case study, an equal amount of capital is used for each trade. For example, if you have a leveraged float worth of $100 000, you may want to put the same amount of funds into each of your trades, say $x. In order to figure out how many CFDs to buy or sell when entering the trade, you would divide $x by the price of the CFD. Say if the last traded price of the CFD was $7.50, you need to divide $x with 7.5 to determine how many CFDs you will buy. You will have to go for a different calculation in order to determine the risk that is involved in the trade.

The risk amount is defined as “how much would you lose if the CFD goes against the direction of the trade, getting you out at the initial stop loss?” The amount at risk in the trade is not as much as the amount you put into the trade. To find out the risk, you need to identify stop loss distance. Stop-loss distance is the difference between your entry and stop-loss price.

For instance, if your stop-loss is $8.00 and entry price is $8.25, this means, your stop loss distance is $0.25. Assume that you have 1200 CFDs to deal with. So in that case, the amount of risk in your trade would be, 1200 multiplied by 0.25, means $300. So in this case, your risk is $300. This is the amount of loss you will face in case the trade goes against you and gets you out at the initial stop. You should add the cost of commission and interest as well in order to be more specific. However please note that the numbers that have been used above are only to illustrate the whole procedure. This is neither a recommendation nor a part of any trading system.

In this fixed dollar trade size model, the number of CFDs that you will buy or sell will not be the same all the time, and the stop loss size will vary as well despite you are putting in $x into each trade. This is why the amount at risk will be different with each trade.

Risk Management Issues in Compounding CFD Trades & Profits

Another important factor in CFD risk management is, whether or not to compound trades or profits. Compounding trades refers to your plan to enter more positions when your floats rise. For example, if you can enter in as many as 10 trades at a time with a given float and if your float grows, in that case, you can go for more trades at once. However, since the CFD prices fluctuate up or down, in an actual market condition it will be more or less than these numbers as the value of your account is updated in real-time on the basis of your profits or losses on your positions.

Now, compounding profits refers to the increase of your funds that you put into every single trade which occurs when your float increases. But the number of maximum positions remains unchanged. For example, if you can attend in as many as 10 trades at a time with the given float and if your float grows larger, then in that case taking larger position sizes will be consistent with the model. However, you need to go through backtesting of your results, in this case, to check whether the profits increase and that the drawdown is in an acceptable level. Usually, this strategy is more applicable in particular cases where the downtrade gets too big than what you would like it to be. In addition, trading a market that involves liquidity issues (for example a smaller market) can increase the probability of getting more slippage after the size of the trade hits a certain point. So we can see that even though it is quite possible to go for compounding profits but it has some drawbacks.