At the end of the day, any trader or investor is in the risk business, irrespective of whether they are aware of this or not. And no investor should do anything with their hard-earned money until they have figured out exactly the kind of returns they are looking to make, how much risk they are prepared to take to achieve those returns and over what time horizon they are ready to tie-up their capital.
No one can be right all the time, and the trick in making money spread betting is not just about being right, but also being quick to identify when you are wrong, in order to minimise any potential losses. Failure to implement sensible risk management could mean that a few bad trades could wipe out lots of small gains which can lead to big losses because at the end of the day it is not how often you get trades right that counts, but, on aggregate how much money you win and lose that is important.
Essentially, there are two ways you can control your risk on each spread betting trade -:
- By the position of your stop loss when you enter the trade. This will be the number of points the stop is away from the entry plus the spread. In other words your total points potential loss.
- By the amount per point that you trade. If your risk (as in 1 above) is 20 points and you bet £1 per point your risk in money will be £20 whereas £50 per point for the same position is a risk of £1000.
So BEFORE you enter the trade, consider where your stop will be and how much per point you are prepared to risk.
Tip: “The first rule of trading is to preserve your capital. Without it you cannot trade.”“My suggestion is that you NEVER risk more than 5% of your capital on any one trade and normally much less.”
So let’s say you decide that £100 is the maximum risk you are prepared to take for this trade. Your total risk is say, 13 points. That will mean you must not go more than £7.70 per point (£100 divided by 13 points risk). You may decide to round up or down.
Of course if you have sufficient margin and are prepared to risk £500 on the trade, then you can afford to go up to £38.46 per point (£500 divided by 13) again you could round up or down to the nearest pound per point.
“Tip: Pick low risk trades. These are trades where, based on your trading strategy, your initial stop can be placed relatively close to your entry level.”
You should go through this process every time you are about to open a new trade so that you govern the maximum risk in money. It can be very easy to open a trade, set your stop and then be astounded at your loss if you get stopped out, particularly if you are trading a share with a normally wide spread.
Make yourself aware of the differing spreads for different stocks and Indices, it is an important consideration in your trading. Cheaper stocks will have smaller spreads (in points) whereas more expensive stocks will have wider spreads. However, as we saw earlier, a more expensive stock is likely to move more each day. This can mean you cover your spread quickly but equally they can go against you quickly. Rolling spreads and daily spreads are smaller than futures (next quarter or far quarter). It is not that trading wider spread stocks is wrong it is just that.
If you keep your maximum risk in money the same for all trades then your position sizes will vary. Knowing and controlling your risk is vitally important for trading success.
“The thing about trading is that a lot of it is about risk and money management. The 1% won’t always work and may have to be adjusted for smaller pots to 2% or more and can be reduced for larger pots. The point is that I always think about the overall impact of a trade. It took me a while to get the point of that but once I did my performance improved.”