Here is the fifth part of our 7 part series titled “The 7 Deadly Financial Spread Betting Mistakes”. Today we will discuss the fifth of the 7 financial spread betting mistakes that financial traders make:
Mistake #5 Taking too much risk
Most online traders take too much risk when trading. This is especially the case for people trading online with financial spread betting.
In futures trading, traders decide how many contracts to buy of each instrument, but in financial spread betting, traders only have to decide how much to bet per point. This makes it much easier to over trade and to risk too much on each trade.
It is also much easier now to trade too frequently, with the temptation to sit in front of the screen all day. It is no longer necessary to pick up the phone to execute your trades as you can access your financial spread betting account 24 hours a day and can trade with ease at the press of a button. This can very easily lead to over trading and taking too much risk.
To get around this it is necessary to have a specific system to follow with specific rules which will govern each of the following:
1. The markets (instruments) in your portfolio.
The selection of markets (instruments) in your portfolio is a crucial factor. It is important to select actively traded markets so that you can exit your trade when you want to. If liquidity in a certain market is low this can prove difficult and expensive as you may get a far worse price than you had expected when you go to exit your trade.
2. How many markets in your portfolio you will trade at any given time
The number of trades that you will have open at any one time determines the total amount of risk that you have. There must be a point at which you do not open any new trades until some prior trades have been exited, or the stop loss in some trades has moved up to the entry level.
3. How much exposure you will have on open trades at any one time
This follows on from point 2. If you are going to risk 2% per trade then 50 trades open at one time would mean that 100% of your account is exposed. This would be an extremely dangerous game to play and the volatility in your account would be extremely high.
If you are only prepared to risk 50% of your account then you can only have 25 trades open at any one time. Obviously as certain trades progress you can move your stops up to break even and then eventually to lock in profit. At this point you could have more trades open but not so much risk exposure.
4. Your bet size for each individual instrument.
Most people who use financial spread betting bet far too much per point. The correct approach is to decide where you will set your initial stops, assign an amount of risk per trade which should be the same for all trades and then subtract your exit price from your entry price. You would then divide the number of points that your stop is away from the entry price by your risk per trade which would give you your bet size per point.
5. The distance your initial stop loss is from your entry price
Most online traders put their initial stops too close to the market and bet too much per point. The correct approach is to use a wider stop and a smaller bet size. Stops which are too close to the market invariably get hit, causing you to get taken out of a trade prematurely. At the same time you don’t want your stops too far away as this will cause you to trade with a reduced size which will limit your potential profit.
6. How you will manage your trade once it is open and when you will exit the trade.
You must have a set point at which you will exit your trade. A good trading system will have specific rules for this and your stop should follow up behind the current price as the trade progresses. Initially moving stops up behind a trade as the trend progresses will enable you to limit your exposure on that particular market and ultimately to lock in profit whilst still allowing the trade to progress.
7. The correlation between each instrument.
Many markets are correlated. Some are highly correlated such as Crude Oil and No Lead Gasoline; others are slightly less correlated, like Soybeans and Wheat. Others have little or no real correlation at all.
If you trade too many markets that are highly correlated you are trading the equivalent of one trade but with much more risk as you have multiple trades. A dramatic move in these markets is likely to cause a severe drop in equity in your account.
8. The maximum drawdown in equity that the system will generate
A drawdown in equity is the distance of the highest point of equity to the lowest point. A good trading system will have a high profit return with the smallest possible drawdowns.
The maximum drawdown that the system has should be within the comfort zone of the trader. Some traders are able to withstand high volatility in their account and larger drawdowns and are subsequently able to capitalize on market moves. Other traders are more risk averse and have to reduce either the number of instruments that they trade or the risk per trade (bet size).
9. The duration of the drawdowns
The duration of the drawdown is how long it takes in trading days to return to new equity highs from the lowest point. A good trading system will recover in a relatively short period of time.
10. The frequency of the drawdowns
The frequency of drawdowns a system has is also a factor. If you trade a system which has frequent drawdowns in equity of 50%+ you fill find it extremely difficult to follow the system over a long period of time, increasing the likelihood that you will abandon the system. Chopping and changing systems will ensure that consistent profits will elude you.
The LS Trader system takes all of the above factors into account and is a robust trading system, which has been optimized in all of the above factors, culminating in a system which has high returns whilst also keeping drawdowns to a minimum. There are specific rules to cover all of these areas meaning that the trader will always know exactly what to do in any eventuality.
In the next part which will be published in the next few days we will discuss Deadly Financial Spread Betting Mistake #6 which is titled “Day Trading and what all day traders should know”.
Until then, good luck in your trading.