CFD/FX Trading Involves Risk. Losses May Exceed Deposits.
Learn best-practice risk and trade management for successful trades

A commonly used tool forForex and Contracts-For-Difference (CFD) trading is leverage, which can greatly multiply your profit or loss. The larger the potential profit, the greater the risk. In fact, before starting to trade Forex and CFD, you need to understand that risk acceptance is a prerequisite for leveraged trading.

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Indeed, there are many Forex trading risks, but there are also various ways to reduce them. We will lead you through the basics of how to minimize your losses using Forex risk management strategies. However, please remember that our aim here is to share knowledge, not advise actions.

What is risk management?
General trading risks

Your profit opportunities are always connected to comparable risks. Forex risk management can be seen as a brief-case containing numerous instruments, which you can use to help keep your trading losses low and potential gain high.

Forex trading risk management is based on four important principles, including:

  • recognizing the risks
  • analyzing and evaluating those risks
  • finding solutions to reduce those risks
  • managing and applying those solutions consistently.

Assessing the market is a primary focal point for new and seasoned traders. Yes the right market position is important – but experienced traders consider risk management equally important.

Leverage effect

One of the main reasons for choosing to trade Forex and CFD is access to leverage. Why? Because leverage offers a reduced margin requirement when compared to a full investment - you put in less to potentially gain more. But remember, if the market does not react your way, you can also lose more too.

UBFX offers Forex trading leverage up to 200-to-one. For example at a leverage of 100-to-one, you can move 10,000 USD with a margin of just 100 USD.

The higher the leverage, the faster you gain profit or loss. If you lose, it may be because of over leveraging - meaning you chose a leverage level with a risk too high for you to manage. While trading with smaller investments is an attractive option for avoiding over-leveraging, it also reduces your potential profit. So, always carefully select your leverage according to your account volume.

Inaccurate market assessment

Forex and CFD trading is subject to consistent market movements and every order starts slightly in the negative because the spread (the difference between bid and ask price) gets deducted on order opening. With these points in mind, it`s little wonder that your market assessment won`t always be right and you will sometimes lose profit. But how much you lose, can be controlled by setting a stop loss mechanism at the final level you are prepared to accept loss. However, bear in mind that setting stop losses too narrowly, might lead to your order being closed on a minimal market movement.

Remember, not every trade will conclude in a profit.

Rapid market movements

The market is constantly influenced by news, opinions, trends and political decisions in milliseconds. Two examples from the many options, are:

  • an influential central bank announcing a major interest rate decision, can cause huge gaps on the trade chart within seconds
  • a professional market player employs large funds to intentionally cause a significant shift in a particular market.

Even if you are actively paying attention to the market, it is not humanly possible to know every change before it happens. Our point? Set up automated stop mechanisms like the stop loss, to close your trading order for you. But remember, the stop loss cannot help you completely avoid loss - just indicate when action can be taken to reduce it.

Market gaps

These are significant leaps in price, that are shown on a trade chart. Market gaps usually occur when the markets are closed, but even open markets can react to unexpected economic news that causes trading orders to close far from the desired threshold. So why is this important? Because even automated mechanisms like the stop loss, can only close orders at the next available quote after the jump. The EUR/USD chart example, shows:

  • an unusually large gap right after a weekend in July 2015, and
  • that there are no prices inside the gap, which makes it impossible for stop loss to trigger before the next attainable market price.
Gap
Risk Management tools
Stop loss - knowing your limit

Quotes can move rapidly, especially when the market is volatile or nervous. A smartly placed stop loss usually reacts much faster than a human trader could, making it one of your most important Forex risk management tools.

Choosing the right stop loss is discussed in countless articles and reports, but there is no `golden rule` for all traders or trades. For each trade, you need to choose the appropriate stop loss limit, by answering several questions.

  • What is the trade`s time frame (remember - the longer a trade is open, the more volatile it will probably be)?
  • What is the target price and when do I expect to reach it?
  • What is my account size and current balance?
  • Do I have any open positions?
  • Does my order size match my account size, account balance, time frame and current market situation?
  • What is the general market sentiment (e.g. volatile, nervous, awaiting news or other external factors)?
  • How long will this market stay open (e.g. is the weekend coming soon or is the market closed overnight)?

As there is no general rule for the stop loss limit, we suggest using our free demo account to learn by doing without taking risks. Here you canpractice a few example trades and test various stop limits in different scenarios. If you have a live account, you can also use MT4 extensions like our trade terminal function, which displays the indicative risk for stop losses in your account`s currency.

Order size

Even the best traders do not achieve profitable trades every time. In fact, a good quota of Forex trades ranges between 5 to 8 profitable trades out of 10. So it`s clearly important to calculate your order sizes with enough trade capital available to outlast market movements.

Choosing leverage

As you know, choosing too high leverage (over leveraging) will increase your risk and a few negative trades can ruin your overall trading result. With UBFX, you can:

  • choose your preferred Forex leverage from 10:1 to 30:1
  • use our trade calculator via MT4 Supreme or our website here, to experiment with different trading scenarios, which may help you select the right volumes for your live trades later.
Conclusion

The Forex and CFD trading market offers exciting profit opportunities via daily long and short orders. But remember, it can also deliver big losses if you do not practice effective trade and risk management. Identifying your weakest links and managing them correctly can help limit your losses, because as you now know - you may win 8 of 10 times, but one loss can instantly remove those gains.

We know that the psychological factors around initial trade failure can be disheartening for beginners, but it is important to understand that loss is part of the overall trading experience. Before making your first live trade, understand:

  • that losses are unavoidable
  • how to psychologically handle losses before they even occur.

This article serves as a trader`s risk management overview, by offering explanations together with useful countermeasures for general Forex and CFD trading risks. However, UBFX does not provide investment consultancy so please:

  • use this basic information to improve your personal risk management
  • be aware that this information only helps you limit your risks - it is not a guarantee or safeguard.

But hey, don't forget that Forex and CFD trading is not all doom and gloom either! Selecting suitable risk management measures and consistently exercising them, can significantly improve your profit/loss ratio for successful trading.