Trading with High Leverage: How to Manage Risk
Trading comes with its associated risks. Some define risk as the chance that the market (or instrument you are trading) moves against your view. Some define risk as the chance of permanent loss of capital. Some define risk as the volatility or standard deviation of the daily returns. No matter how you define risk, one thing is certain – trading is not risk-free. If you are going to trade cryptos or any other instrument, then it is important for you to manage risk.
Types of Risks to Consider
There are two types of risks that a trader needs to understand. The first is stock or cryptocurrency risk which is specific to the instrument being traded. If you bought the stock of a company and that company faces a black swan event, then only the stock of that company gets affected. Black swan events could be a governance issue, a fraud, some overnight event that deeply impacts its business, etc. Think of the GameStop episode. Cryptocurrencies tend to face frequent price volatility from events of this sort because the cryptocurrency space is fast-evolving. Any news of forking, hacking, government bans, etc. impacts a cryptocurrency.
The second type of risk is a market risk or systemic risk. This kind of risk is system-wide and affects almost all securities or instruments traded on the market. These risks are driven by broader events like macroeconomic situations, wars, pandemics, etc. Think of the 2008 financial crisis when the entire market in the US fell more than 40% or the COVID crash of 2020. In such cases, it doesn’t matter what stocks or cryptos you hold. Everything gets affected. It is like a bunch of boats in the ocean. When the tide rises, all boats rise and when the tide goes away, all boats sink lower.
There are execution risks as well. For example, if you plan to buy or sell a cryptocurrency or stock at a specific price, you open your terminal and prepare yourself to hit the buy/sell button. However, if the instrument that you are about to trade is too volatile and if its price is moving too quickly and frequently, then there is a chance that your order doesn’t get filled at your intended price. Instead, it gets executed at a much higher/lower price, potentially resulting in a loss. This kind of slippage is very significant if you are trading large quantities.
What Happens When You Don’t Manage Risk?
If you don’t have basic risk-management rules in place, then there is a lot that can happen besides loss of capital. If you trade leveraged products like CFDs or derivatives, then your losses could go well beyond your deposited capital. After all, CFDs allow you to take positions that are much larger than the capital that you have put up. So, running a negative balance leads to something popularly known as a margin call. The broker may demand that you deposit additional funds to cure the negative balance. Margin calls can also result in brokers squaring off your positions automatically, regardless of whether you were in profit or loss at that time. Losing your trading capital through a loss is bad enough, facing a margin call makes it worse.
How Can You Manage These Risks?
You can use some of Cerus Markets’ features to manage your risk:
Stop Loss: You can use the stop loss to define the maximum amount that you are willing to lose. While placing a trade, there is an option to set a stop loss as well. Setting a stop loss means that your trade will be closed or squared off as soon as the price reaches your set stop loss. Stop losses usually work unless the price gaps up or gaps down. A gap is formed when there is a noticeable difference between the closing price and the opening price the next day.
Alerts: Cerus Markets allows users to set alerts as well. So, if you want to be reminded when the price crosses a certain level, then you can set an alert through your trading terminal. Alerts work well if you are worried that your stop loss will not hit at its intended level due to high volatility. Alerts are also a good nudge for you to log in to your trading terminal and be in front of the screen at a critical moment.
Limit Orders: Limit orders allow Cerus Markets users to set a price at which to enter a trade and exit a trade. This eliminates the execution risk that was discussed above. Sometimes, when prices are moving way too quickly, it might not be manually possible to execute a trade at the desired price point.
Sometimes, a market order gets executed at a level far away from your entered price point. This can happen due to high volatility or illiquidity. In order to buy, there has to be a seller. If there are very few sellers and you are looking to buy, you might not find a seller willing to sell at your intended price point. A limit order stays in the system and waits for a seller who punches in a trade at your price point.
Position Sizing: This is a more general risk management technique. You should size your position correctly. If you are only willing to lose, say, 2% of your trading capital, then you will enter a trading volume where the risk is only that much. If you trade double the volume, then your potential loss amount goes up to 4%. You will limit your quantity to match your loss limit.
Have A Mental Kill Switch: Have a predetermined loss amount in mind. If at any point, your mark-to-market loss hits that level, then you exit the trade completely regardless of whether things are about to turn around or not. It is like a kill switch that has to be executed without any excuses or reasons.
At Cerus Markets, we are dedicated to making traders informed and aware of the benefits and risks associated with trading. We want traders to trade with safety and risk management in place. If you are ready to start trading, we encourage you to sign up for a waitlist to be the first to get access to the platform and participate in the $10,000 Prelaunch Giveaway. Sign up for the Giveaway via cerus.app.