Trading assets with the highest risk level

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What are some of the highest reward-high risk investments?

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Understanding trading risk and applying risk management

It’s all too easy to disregard the importance of risk management when it comes to trading. But remember, even if you’ve been enjoying an excellent rate of success in percentage terms, you could all too easily lose a high proportion of your gains should just a couple of trades go wrong.

That’s the danger, unless you use a robust risk management system to ensure you’re keeping the losing trades under control.

Serious planning

Becoming a consistently profitable trader over the long term in large part boils down to being able to professionally manage both your profit points and your stop-loss orders. Rather than stumbling into a trade with no strategy on a wing and a prayer, this is all about serious planning.

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  • Firstly, we need to understand why we are taking the position and related to that is the likely profit target we should set, from entry point to exit point.
  • Secondly, we should guard against the unexpected, just in case things don’t go as we anticipate.

Consistency

If we can minimise our losses from the trades that go wrong and maximise the profits from those that go right, we should be well on the way to becoming a consistently profitable trader. We’ll be all-the-more successful if we can also ensure that a higher proportion of our trades are profitable than not.

This part of the equation goes back to being sure why we’re making the trade in the first place.

1% rule

Many traders swear by the so-called 1% risk rule. In short, this means that when a trade doesn’t go our way we never lose more than 1% of the value of our trading account. Setting such a relatively low limit on maximum losses from any single trade could put you well on the way to long-term profitability.

What this means is that if you have a trading account with £10,000 in it, you’ll set your stop losses to ensure that the maximum you lose on any given trade is £100. While it may appear conservative, this could easily add up to a good long-term return, even if we set our minimum profit target for each trade at just 1.5% of the account.

So, even if just three out of five trades in any given day were profitable, we would still be making an average of £250 profit on each trading day.

On certain trades we may choose to seek a higher level of profit if technical and fundamental analysis tells us our profit target on a given trade should be higher. This should increase our long – term profits, especially if we maintain the 1% stop-loss discipline to minimise our losses.

Optimum

The 1% rule won’t necessarily be optimal for everyone. For instance, if you have a very large trading account, say with £80,000 in it, you may want to set your maximum loss at a lower percentage level.

Conversely, professional traders, with a long track record of delivering consistent profits, may choose to set the maximum stop loss at a higher percentage of their trading account, perhaps as high as 2%, or somewhere in the middle, at 1.5%.

If this were the case, however, they would also need to target a higher percentage level of profit from each trade.

For many traders though, the 1% rule engenders a comforting level of self-imposed discipline. Personally, even with a trading accounting of £50,000, I’d rather lose a maximum of £500 on a single trade than £1,000.

Risk controls

If we impose proper risk controls and aim for reasonable profit levels on each trade, then it follows that the level of funds in our trading account will closely determine how much profit we make on an average trading day.

Underfunding your account but going for fairly high levels of daily profit is a risky strategy that could see your trading account balance rapidly depleted. It’s important then to have in mind an average daily profit target so as to ensure that there is sufficient capital in place.

For instance, if we’re aiming for an average daily profit of £500 then we are likely to need a trading account with £20,000 in it rather than £10,000. For those of us who are fairly new to trading, it’s well worth practising with a demo account to get a good idea of the profits we should expect from our strategy.

Some of us may also wish to go back to using a demo account when we want to experiment with new strategies.

And remember, the nature of trading means that some days will be a lot more profitable than others. There is an emphasis on the word average because we shouldn’t feel under pressure to get to that level on every single trading day. On some days, we may well make £1,000, double the daily average target, while on other days we may even incur a net loss.

Risk:reward

Risk:reward ratio is an important concept in trading, being a fundamental element of any trading strategy.

Let’s go back to the earlier example of a £10,000 trading account where we were ensuring that a maximum of 1% of the account value was at risk on any one trade, while also setting a minimum profit target of 1.5% of the account on each trade.

What was our risk:reward ratio? £100 was at risk, while the profit target was £150, so the risk:reward ratio was 1:1.5

Win rate

Some investors claim that the minimum risk:reward ratio for any trade should be higher than in this example, with many typically citing 1:2.

However, in a day trading strategy where you’re making at least five trades each day, this may not be necessary. At the same time, this does depend on what percentage of the trades are successful. The higher our win rate, then the lower the ratio needs to be.

It’s quite intuitive that if our risk:reward ratio is 1:1, then we need a win rate of over 50% to be profitable. Using this neutral risk:reward ratio, we breakeven with a 50% win rate.

Meanwhile, with a risk:reward ratio of 1:3 we only need a win rate of 25% to breakeven. Going back to our risk:reward ratio of 1:1.5, then we would need a win rate of 40% to breakeven.

In our earlier example of a £10,000 trading account using a 1:1.5 risk:reward, giving us an average profit of £250 per day, our win rate was 60% (three out of five trades were profitable).

Screening trades

Using our historical track record of trades, we should be able to get an estimate for our long-term win rate. We then need to ensure that our risk:reward ratio stacks up to give us our desired average trading profit.

If you don’t consider yourself to have a sufficiently long track record of active trading to achieve a reliable win rate, then you could also apply the trading results from a demo account. Once you’re happy with your risk:reward target, you’ve got the ability to screen trades according to whether they meet your minimum requirements.

While it might be tempting to take on trades that fall below your minimum threshold, over time this approach could significantly erode profitability. So, if you calculate the risk:reward from a trade at 1:1.2, and your minimum is 1:1.5, then the trade doesn’t qualify for your strategy. If a trade falls short of your risk:reward, then it’s best to pass it by.

Billionaire George Soros once said: “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

It is ok if a trade profile is above your minimum risk:reward threshold. Having more trades with higher than average payoffs should boost our average profits over time.

R-multiple

A popular way of assessing the potential profit of a trade is by using the so-called R-multiple. R itself, also referred to simply as risk, measures the distance from where your order is transacted to the point where you have implemented your stop loss.

For example, suppose we implement a buy order on the FTSE 100 at 6,923 and a stop-loss order at 6,896, with a profit target at 6,990. R, the distance between the buy order and the stop loss, is: 6,923 – 6,896 = 27.

Next, in order to calculate the R-multiple we need to know the distance between the buy order and the target price. This is 6,990 – 6,923 = 67

We can now calculate the ratio of the potential profit to the potential loss of the trade.

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Hence our R-multiple is 2.48:1.

Our potential profit is therefore 2.48 times our potential loss.

Tight control

While analysis on some trades may tell us to take a wider stop loss than others, and wider profit targets than others, we can maintain risk management control by reducing the size of such trades.

In this way, we should be able to keep tight control over the percentage of the account that is at risk on any one trade.

If you’re committed to keeping the loss on any one trade to just 1% of your trading account, then it means you may need to decrease the leverage on trades where technical analysis tells you the stop loss should be at a wider absolute level than others.

This is important because having too narrow a stop loss could mean that our trades will be prematurely closed out.

Leeway

It’s not a good idea to make your stop losses so narrow that you’re essentially attempting to take “no risk” trades. Even if you’re getting your entry points mostly right you still need to allow some leeway for brief retraces. Otherwise, you could be missing out on too many highly profitable trades.

As an example, suppose we’re tracking the Dow Jones 30 index. There have already been some falls in the index on bearish sentiment, but we notice the index appears to have entered a consolidation phase over the past few hours and is trading within a narrower range.

We view the peak point in this relatively narrow range at 24,130, a price level the index hits twice before retracing, marking an area of resistance. The lowest point in this trading range is 24,108.

In the belief that the index will likely breakout to the downside, we set a sell order at 24,108, with a stop loss just a short distance away at 24,115. We were right in thinking the index would breakout to the downside; it does so within the following 40 minutes and the sell order is transacted at 24,108.

We set a profit target for the trade of 44 points, twice the height of the prior trading range. After reaching 24,103, the index bounces up to 24,116 and the trade is closed out due to the stop loss, leaving us with a small loss on the trade.

However, within seconds the index is back down again and heading well past 24,103. In fact, it has reached the original profit target of 44 points just ten minutes later, and is trading at 24,085.

In short, we missed out on a profitable trade because we set the stop loss at a much too narrow distance from the point of our buy order.

Had we instead used the last upper price levels from the consolidation phase, say at 24,130, we would have had a profitable trade.

Counterproductive

Clearly, setting the stop loss at an overly narrow distance away from your market order can be counterproductive. Rather than using fixed distances arbitrarily, you need to be able to take into account technical indicators such as moving averages along with basic factors such as support and resistance levels.

At the same time, you should be comfortable with the level of potential monetary loss implied by the position of the stop loss. If you use the 1% rule, for instance, you must ensure that the stop losses themselves are not set an overly narrow level from your market orders.

At times of higher market volatility you should also be prepared to consider implementing wider stop losses compared to days when market volatility is lower. When volatility is higher you’ll notice that your usual stop losses have a tendency to get closed out more often.

Reviewing your trades

Properly managing risk and your overall trading strategy means you should document your trades every day. This means having a record of the level at which orders and stop losses were made and the outcome of each trade.

Understanding why a trade wasn’t successful or how profit could have been further maximised could help you to become a better trader in the long run.

At the same time, we need to compare our trading actions and results to our own pre-planned trading rules and strategy. In this way, we can aim to assess our actual compliance with the trading strategy as well as our overall effectiveness.

Reviewing your trades should help ensure you’re obeying your own rules but also allow you to pinpoint your weaknesses, ultimately enabling you to improve long-term trading performance.

What you trade

There is also the small matter of the assets we choose to trade. These days, online trading platforms enable you to trade a wide variety of stock indices, individual shares, commodities, forex and cryptocurrencies.

You may be drawn to a particular asset class because you feel you better understand what drives it than others. However, you should always bear in mind that spreads can differ quite significantly between one asset or another.

For instance, a stock market index such as the highly popular Dow Jones 30 may have a much tighter spread than a cryptocurrency. Spreads can impact your trading strategy, with wider spreads potentially raising your costs of trading.

You therefore need to consider whether the spreads on offer in a given asset are a good match with your trading strategy.

Correlation

You also need to consider the correlation between assets, especially when you have more than one trade open at any given time. Having two positions open in different assets that are positively correlated, as opposed to two positions in assets that are negatively correlated, increases your overall risk.

As an example, suppose you open long positions on both the FTSE 100 and the Dow Jones 30. They are positively correlated as they are major global stock market indices and will more often than not move in the same direction as one another.

Conversely, suppose you simultaneously had a long position in gold and a long position in the S&P 500. In this case, you might often observe a negative correlation as gold may fall when risk appetite is strong but rise when investors pull their funds from stock markets and put their money in safe havens. As one of the world’s other major stock market indices, the S&P 500 tends to rise when risk appetite is strong.

Mapping your risk and profit

By planning our trades and having a proper risk management strategy, we should know our potential profit and maximum loss before we embark on any given trade. This is in stark contrast to an amateur approach that can be highly charged by emotion or gut feeling.

If a price moves rapidly against us when we don’t have a stop loss in place, we may easily be tempted to holding on to the position in the hope that the situation will reverse itself. Of course, we could then easily find that we rack up even greater losses.

Similarly, without the discipline or a pre-planned profit target we might be overly tempted to hold on to a winning trade for too long, only to watch the profits evaporate before our eyes.

In contrast, setting reasonable profit targets and maintaining strict control over our losses should help us boost our trading profitability over the long term, while firmly eliminating unnecessary nasty surprises and emotion from the equation.

Documenting our trades and then constantly reviewing our execution and performance should also help us to become better traders.

Binary trading vs. CFD trading: What is the difference?

Contracts for difference (CFD) and binary options are some of the most popular trading instruments available to online traders.

Many marketers wonder how these tools differ and which ones to choose to win better.

To understand it, we must analyze in detail the two trading platforms and put them side by side to see exactly what is what.

In this article, we will briefly review the similarities between CFD trading and binary options trading and we will make a more thorough assessment of their differences and we hope to draw a rational conclusion.

What Are CFD’s and Binary Options

Many beginner traders confuse these concepts. Therefore, first of all, we want to inform you briefly about each of these forms of trading in the stock market. So, what are then CFD’s and binary options?

CFD’s (Contracts for Difference)

CFD means contract for difference. In short, a CFD is an agreement between you and a broker to pay each other the difference between the price of an asset (such as gold, EUR/USD, Microsoft shares, etc.) at the time the contract is made and its subsequent price when it decides to terminate the contract, that is, close the transaction.

It means that you do not own the real asset, but you make a contract with the owner (in this case, the trading platform) to resolve the difference between you when the deal is over.

This opens the door to many opportunities, such as the fractional ownership of shares, short shares in assets that do not offer them and much more.

Binary Options

Binary options are often referred to as “yes or no” investments. If you believe that an asset will be quoted above a fixed price, you are predicting a “yes” and buying the binary option. If you believe that an asset will fall below a fixed price, you are forecasting “no” and selling the binary option.

There is a low barrier to enter. A binary option contract will not cost more than $100. You are not buying an underlying investment or even the option to buy an underlying investment. You are simply placing a bet on how the price of that investment will move.

These contracts always close at $0 or $100; You win or lose. If it correctly predicts the movement of the price, it is on the winning side of the operation, and the person on the other side of the contract, who incorrectly predicted, is on the losing side. Your profits or losses can not exceed $100 in a single contract, which means that your exposure to risk is limited.

Limited, but far from not existing. You can negotiate multiple contracts to increase potential profits; but at the same time the size of the possible losses increases.

To perform a binary option you must follow three main steps:

  • Decide on an asset or market to trade.
  • Decide an expiration date or time for the option to close. Most trading platforms allow you to sort by expiration date, so you can see contracts that expire within the next hours or days. Most contracts will expire at the end of the trading week, except those linked to economic events.
  • Decide if you want to buy or sell the binary option, according to the exercise price and the expiration date. The exercise price is essentially a line in the sand. If you believe that the asset will be above the strike price when the contract expires, buy the binary option. If you believe that the asset will be below the strike price, sell the binary option.

Similarities between CFD’s and Binary Options

CFD’s and binary options are similar in the following ways:

  • They are derivatives: it is not necessary to own the underlying asset to trade in the asset.
  • They have short trading periods: for both binary options and CFDs, traders can select trading periods from one hour to a week depending on their business objectives.
  • Predicting the movement of prices: both trading instruments involve making predictions about the market prices of the underlying assets.

Differences between CFD’s and Binary Options

Although CFDs and binary options have some similarities, these two trading instruments are also markedly different. The main differences include:

Risk Level

In binary options trading, the operator is usually aware of the possible loss or gain that will be incurred depending on the movement of the price of the underlying asset. However, with CFD operations, it is not possible to determine in advance what you can earn or lose with the fluctuation of market prices. This is because CFD transactions involve negotiating the difference between the entry and exit prices of the underlying asset.

Advanced traders can earn more dividends by trading CFD. However, the level of risk in CFD trading is considerably higher than the binary options trade.

Investment Amount

CFD transactions, unlike binary options trading, involve the payment of commissions and fees for each transaction you make. This is because CFDs are financed with borrowed money, so traders can trade with numerous underlying assets at a reduced price. Each broker has its own commission structure.

When it comes to binary options trading, traders are not required to pay fees or commissions in addition to the initial investment. No fees are paid, even if the operation ends without money, that is, even if you lose. In fact, many binary options brokers offer a return of between 10 and 15% of the money exchanges.

Instead of reimbursements, CFD traders can protect themselves against losses by “stopping” their own losses. But stopping losses can only be applied when losses are already imminent.

Range of Tradable Underlying Assets

CFD trading gives you access to a much broader set of bases that includes bonds, currencies, indices, etc. On the contrary, binary options trading requires the existence of an underlying asset; This currency and the average index can not be negotiated using binary options. If you are looking to access more bases to operate, CFDs offer a better option.

Conclusion: Do We Have a Winner?

Yes, of course we have a winner: the trader! The trader is the final winner of this “battle” between OB and CFD because with this new CFD trend, we have more options and more negotiation styles. We do not believe that one is better than the other. They only have a few differences and operators will have to decide which style suits them best. If you are a trader who wants quick wins of 60 seconds, then binary options are your game. If you do not want to worry about where to put your “Stop Loss” and “Take Profit”, once again, the binaries are for you.

On the other hand, if you are a patient operator that wants to keep good trading for longer, then CFDs are for you. Because in the end, the patience of the trader who chose this tool, is much better rewarded. If the transaction closes successfully, you will earn much more money, and this is the goal of any trader!

In the end, it’s up to you if you want to invest a little time and learn a new way of trading or follow the known path.

If you decide to try the CFD trade, Libertex will be happy to offer you the best conditions. Our CFD service covers a wide range of asset classes. Get more information about CFD operating costs. Also for beginners, we are pleased to offer a demo account, through which you can practice CFD trading without taking any risk.

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CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you can afford to take the high risk of losing your money.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage

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Risk warning: Contracts for Difference (‘CFDs’) are a complex financial product, with speculative character, the trading of which involves significant risks of loss of capital. Trading of leveraged CFD products carries significant risk. Trading CFDs, which are a marginal product, may result in the loss of your entire balance. Remember that leverage in CFDs can work both to your advantage and disadvantage. CFDs traders do not own, or have any rights to, the underlying assets. Trading CFDs is not appropriate for all investors. Past performance does not constitute a reliable indicator of future results. Future forecasts do not constitute a reliable indicator of future performance. Before deciding to trade, you should carefully consider your investment objectives, level of experience and risk tolerance. You should not deposit more than you are prepared to lose. Please ensure you fully understand the risk associated with the product envisaged and seek independent advice, if necessary.

Marketing Communication: OM BRIDGE (PTY) LTD does not issue advice, recommendations or opinions in relation to acquiring, holding or disposing of any financial product. OM BRIDGE (PTY) LTD is not a financial adviser.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Demo Account!
    Free Trading Education!

  • Binomo
    Binomo

    Good choice for experienced traders!

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