CFD trading is a popular form of investment opportunity in Singapore, and more and more Singaporean traders are taking part in it. However, as a form of derivative trading, CFDs are more complex than ‘traditional’ securities trading. To ensure traders make the most of their trades, they should have a sound risk management strategy in place.
This article will begin with a definition of what CFD trading is. Then, we will examine whether CFD trading is regulated in Singapore, and finally, we will investigate how you can mitigate the risks encountered in trading. If you are keen to find out, read on. Alternatively, you can skip to the final section if you want to know more about the risk management strategies for CFD trading that you can use.
What is CFD trading?
To begin with, Contract for Difference (CFD) trading is a form of derivative trading that allows traders to speculate on the price movements of financial instruments without owning the underlying asset. In other words, CFD traders can potentially profit from the difference between the opening and closing prices of the asset directly, if the difference is a positive one.
In CFD trading, traders also have access to the use of leverage. Leverage allows them to control a larger position than the amount of capital they have available in their trading accounts. However, leverage is a double-edged sword, as any adverse movements in the market may lead to substantial losses that could exceed the trader’s initial deposits.
Is CFD trading regulated in Singapore?
In Singapore, CFD trading is regulated by the country’s central bank, the Monetary Authority of Singapore (MAS). Particularly, this regulation is under the Securities and Futures Act (SFA). The MAS requires all CFD brokers to be licensed and regulated, and they must adhere to strict rules and regulations to ensure the protection of investors.
The regulations include requirements for capital adequacy, risk management, customer protection, and transparency in pricing and fees. This can be a great way for Singaporean traders to ensure their funds are protected and they are receiving fair price quotes when trading.
5 risk management strategies for trading CFDs
Knowing the above, we can move on to investigate 5 risk management strategies traders can employ when trading CFDs to potentially maximise their profits. Remember that each trader’s profile is different, and therefore, your needs may not be the same as the next person’s. Therefore, it is important to take the below as general tips that you can adjust to your preferences.
Choosing the right broker
The first thing you should do to keep your risks at bay is to select the right broker and the best CFD trading account for you. This means doing your research and finding one that is MAS-licensed. This can make a world of difference, as the MAS ensures your broker will adhere to strict national rules and regulations to ensure the protection of your funds and information.
Use stop-loss orders
When trading, you should also use stop-loss orders. Stop-loss orders are market orders that allow you to limit the potential losses you may incur when you trade by automatically closing out a trade if it reaches a certain price level. This can help your cut your losses early in depreciating markets, especially if it happens very rapidly.
For example, let’s say you are trading CFD on a particular stock, and you had purchased the stock at a price of $100 per share. You believe the stock will increase in price, but you also recognise that it could potentially decrease in price. You can then place a stop-loss order at $95 per share to protect yourself from this loss. This gives the stock a bit of room to fluctuate.
If your predictions are wrong and the stock does indeed dip in price and reaches $95, the stop-loss order would automatically trigger and close your position, limiting your loss to $5 per share. This is a good way for you to make sure you can safely exit your positions without having to keep your eye on the market all the time. In the same situation, if the stock price does rise, you can monitor its appreciation and exit the market when you want to.
Use leverage with restraint
As mentioned, leverage can amplify your gains substantially, but it can also amplify your losses. You must understand the risks involved in CFD trading with leverage and use it with restraint. You may consider using a smaller leverage ratio than you can access, particularly if you are uncertain about an instrument and the direction in which it is going.
For example, your broker may offer you access to a leverage ratio of 1:50 when trading CFDs. However, knowing you just started trading CFDs and you do not have much experience, you may want to use a smaller leverage ratio of, say, 1:10. If you have $10,000 in your account, instead of opening a position worth $500,000, you will start with a position of $100,000. This way, you will not be taking too big of a risk as you are just starting out, but you will still be able to make a sizeable profit if the markets move in your favour.
Diversify your portfolio
An important aspect of risk management is portfolio diversification. By investing in several different assets and products, you can spread your risk across them. If you would like to stick to CFD trading, consider trading multiple CFDs across different asset classes, such as stocks, commodities, or forex. Alternatively, you may branch out and trade other products, such as traditional investment assets like forex, stocks, indices, and commodities, or other derivatives, such as options and futures.
When you diversify your portfolio, you should remember to research each instrument and product thoroughly. You should also aim to understand whether there will be relationships between your investments. For example, the price of AUD is greatly linked to the price of gold and agricultural products. When the price of gold rises, the AUD tends to appreciate, as Australia is a big exporter of gold. Therefore, you should make sure your trades do not contradict this sentiment.
Develop a sound trading plan
Lastly, a trading plan is a critical risk management tool that helps you define your trading strategy. A sound trading plan includes a run-down, in detail, of your investment objectives, your trading strategies and techniques, your approaches, and when you wish to trade. It should also include your active hours, your balance, and the markets you wish to participate in. Most importantly, it should include your risk tolerance and any exit strategies you have in mind.
Once you have a trading plan, you should stick to it. Of course, it will require review occasionally, and you should never be stagnant when trading. However, sticking to a trading plan in the short-term can help you discover your own strengths and weaknesses in trading, and it can help you more accurately evaluate your performance and progress.
Furthermore, having a sound trading plan and sticking to it can prevent you from making impulsive decisions when trading – decisions motivated by greed, fear, or other negative emotions. This can help you stay on track with your goals and plans, and it can also potentially limit the number of losses you incur.
The bottom line
Trading CFDs involves significant risks, and it’s essential to have a solid risk management strategy in place. By using choosing a reputable broker, using stop-loss orders, managing leverage, diversifying your portfolio, and developing a sound trading plan, you can mitigate the risks involved in CFD trading and increase your chances of success.
