Trading mistakes can easily be made by even the most experienced professionals. Most mistakes made by traders occur as a result of a lack of preparation, data or control. Whilst it is important to learn from your errors, it's even better and much cheaper to learn through the errors of others.
Below are some of the more common errors made by CFD traders:
1. Extreme Gearing.
One of the key benefits of CFD trading is the ability to gain exposure to a stock, index or currency contract with a comparatively small investment. Instead of having to pay for the full notional value of the CFD position CFD traders can enter into positions with margins as little as 5% and in many cases less. One must always note that although a smaller capital outlay is necessary to open the position the Contract for difference trader continues to be subjected to the price movement of the share CFD for the total notional value of the position. A Contract for difference trader trading a CFD at 5% margin is leveraging their initial outlay by 20 times, meaning a $5,000 deposit could be used to open a $200,000 CFD position.
As only a portion of the face-value of the trade is outlaid when buying and selling CFDs a tiny price change may well lead to sizeable gains but also considerable losses. For example when trading a CFD with a margin of 5%, a price rise of 1% in the underlying instrument may result in gains of 20%, on the other hand, if the price fell by 1%, it may result in a loss of 20% of the amount required to open the position.
It is important to keep in mind that leverage can be a double-edged sword not only can it work for you but if not handled properly it might also work against you, often novice trades pay no attention to the fact that if unmanaged leverage can lead to sizeable losses.
2. Not understanding the impact of trade sizes on your account
Because of the gearing related to CFD trading, relatively small outlays can result in sizeable moves within your whole account balance.
For instance buying 10,000 CFDs priced at $2.40 with a margin of 5% involves an outlay of only $1,200. With an outlay of only $1,200 you could hold a $24,000 CFD position. Should the value of this position move one cent it would have an impact of $100 on the profit or loss on the traders account.
If the price of the this position increased by 12 cents a return of $1,200 would have been made. However, if the value of the position fell by the same quantity a loss of $1,200 would have been made.
The overall impact of any price movement will depend on the traders overall account balance. For a trader with an account balance of $1,500, the aforementioned trade would have had a big impact on the traders account profit and loss. Should a trader with an account balance of $40,000 take the same position the impact would be much less significant.
A loss of $1,200 on a $1,500 account would result in 80% of the entire account balance being lost. However, a loss of $1,200 on a $40,000 account would result in a loss of only 3% of the account balance.
3. Buying and selling in too large parcels
You must work out the exposure of your trade size before placing the trade. It is not uncommon for beginner Contract for difference traders to simply trade the maximum size available to them according to their account balance without taking into account the amount of market exposure associated with the position.
There are a number of techniques traders can adopt in order to calculate position size. A simply strategy is to work out an appropriate amount of risk capital should the trade go against you and work out an acceptable position size base on this.
Should you wish to restrict losses on any given trade to $200 you'd calculate your position size determined by your stop-loss price. For instance, if the CFD was priced at $1.40 and you stop-loss was at $1.15 your risk amount would be $0.25, to determine your position size you would simply divide the loss you'd be prepared to take by the risk amount. In this case this would be $200 / $0.25 = 800, as a result your position size should be 800 units.
The strategy outlined above is called fixed fractional position sizing in which a specific percent of the overall account balance is risked on each trade. Other methods incorporate allocating a fixed dollar quantity to every trade, buying or selling a fixed quantity of Contracts for difference in each trade or varying the size trades depending on the profitability of your account.
Using a position sizing strategy may help you prevent the mistake of placing all of your eggs in a single basket.
Author Resource:-
Matthew Jones is a expert CFD trader with one of Australia's most well-liked CFD providers IC Markets. Matthew has published a number of textbooks and held a number of seminars on trading CFDs you can obtain many of his notes on CFD trading for at no cost.
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