In Part 4 – What to expect…
In both cases, determine the maximum dollars you are prepared to lose. For this example, I am using $500.
When using a fixed parcel size method, divide the dollars at risk, $500, by the face value of the contract, say $10,000, and multiply by 100 to obtain a percentage. Note that you should use the face value, not the margin requirement, in this calculation. The stop will need to be placed 5 per cent (500/10,000 × 100) below your entry point to reduce your risk to an acceptable level.
If this trade was to go wrong, then the share would drop by 50¢ × 1,000 CFDs, causing a loss of $500 plus any brokerage and slippage.
When using a fixed-risk calculation the entry point remains the same and the placement of the stop is decided on.
In both examples, the risk is the same at $500 excluding brokerage and slippage, even though using the second method, nearly twice as many contracts are bought as in the first. It is also important to understand that at no time have we considered how much margin is required to trade these amounts of money.
Gains and losses occur on the face value of the contracts held, not the margin requirement, making it important to understand how large a position you are trading. The margin requirements vary from share to share, with a $25 000 position requiring as little as $750 in initial margin, or even less for a CFD index position. It is not the initial margin but the variation margin that will affect your account most strongly. For more information on the variation margin and how that works please refer to day 1 of this 7 day CFD tutorial.
When entering a position always calculate your risk and size your positions accordingly. This is an important aspect of your success in the CFD market.
Coming up next…
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