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Best Risk Management Techniques for Leveraged Trading Strategies

Here’s a look at how to calculate stop loss and trailing stop and how to combine them for powerful risk management.

Disclaimer: This article is an educational guide to CFD trading and the financial markets and should not be considered as advice. Trading CFDs is high risk. Always ensure you understand the potential risks and rewards associated with trading before you trade.

 

Leverage is a powerful tool for experienced traders, but it does come with risks. Being able to identify the risks involved is the first step towards mitigating them. Let’s take a look at some of the risk management techniques used most often by seasoned traders who trade with high leverage.

 

This Combo Pack is Popular

You may already be using stop-loss orders for downside protection, where your position gets automatically sold at a predetermined price to stem losses in case the market moves against you. Experienced traders often pair this with trailing-stop for a more robust exit strategy.

However, calculating stop-loss when leverage is involved is not so straightforward. Here are three ways to do that.

 

3 Techniques to Calculate Stop-Loss

Irrespective of the method, the stop-loss calculation requires you to consider how much you are willing to lose on a particular trade. Let’s say you buy a FX pair with a leverage of 30:1. You invest $10 to open a position of $300. Although you’ve invested only $10 for this position, your loss will include the leverage if the market moves against you.

1. Percentage Method:
Here, the stop loss order is set as a percentage of the buy price. You could consider a ballpark of 10% of the buy price. So, your stop loss order may be set at $270, for the position you opened at $300. The maximum you lose if your trade goes wrong is $30. If you’re using very high leverage, you may set the stop loss much lower than this ballpark figure to contain losses in case the markets move against you. This method works best in markets that are not highly volatile, unlike forex and commodities.

Remember

A $30 loss on an investment of $10 may seem extreme. However, risk needs to be considered from the perspective of potential gains. Stop loss is a trade-off. Setting it too far from the buy price could mean higher losses if the market moves against you. What’s equally bad is a stop loss order being so close that it is triggered even with the instrument’s normal price fluctuations or a small spike in volatility, while maintaining the overall trend.

 

2. Technical Support & Resistance Method:

In this approach, the stop loss is set below the support for buy positions, and above the resistance for sell positions.

 

3. EMA Method:

Seasoned traders often use Exponential Moving Averages (EMA) on a 15-minute chart to determine the stop loss levels.

The 5-EMA crossing the 20-EMA from below is considered a potential opportunity to go long, provided both these indicators and the asset price are above the 50-EMA. You may wait for the asset price to successfully test the zone between the 20-EMA and 50-EMA twice before placing the buy order. The stop-loss order is placed 20 points below the 50-EMA.

For short selling, the 5-EMA crossing the 20-EMA from above is considered a potential opportunity to open a trade, provided these indicators and the asset price are below the 50-EMA. The stop-loss order is placed 20 points above the 50-EMA.

Did you know?

The golden rule for placing stop-loss among intraday traders is to keep the risk-reward ratio at 1:2.5 or 1:3.

Combining Stop-Loss with Trailing-Stop

This risk management technique means you’re using a stop-loss order with every position, but the price is not fixed. Instead, the stop-loss price is a certain percentage of the market price and keeps adjusting to market movements.

Let’s say you’ve decided to go long on gold. When the price of the yellow metal increases, the price of the trailing-stop increases by a similar degree. Setting the trailing stop at the right interval is important, as this keeps you in a trade for the duration of the trend. When the price of gold stops rising and subsequently declines, your stop-loss order is executed at the new price that it had been dragged to. This allows you to lock in more profits while the market is moving in your favour, and close your trade when the trend reverses, protecting you from losing money.

Since the trailing stop automatically adjusts as the price of your asset changes, it is more effective than stop-loss orders in maximising your profits. However, it is also tricky to apply it in fast-moving markets.

 

Popular Strategies for Trailing Stop-Loss

Some of the best strategies include:

1. Percentage Method:
The simplest way is to calculate trailing stops at a percentage below the buy price. As your asset price rises, the trailing stop will also climb by a similar percentage and remain 10% below the current market price.

 

2. Average True Range (ATR):
This is based on the current market volatility, which makes it a good method across instruments. Expert traders often choose the 3-ATR or 4-ATR to determine the trailing stop-loss (the ATR could be set to minutes, days, months, etc). If you’re going long, subtract 3-ATR from the highs to get your trailing stop-loss. If you’re going short, add 3-ATR from the lows to get your trailing stop-loss.

Did you know?

Intraday traders using high leverage often use 2-ATR on hourly charts, while those with long term trading horizons may use up to 6-ATR on daily charts.

 

3. Parabolic Stop and Reverse (SAR):
This indicator uses the latest and most extreme price (EP) and combines it with an acceleration factor (AF). So, as the market continues to move favourably, the movement of the trailing stop price will accelerate.

For going long, you may consider using Prior PSAR + Prior AF to calculate the price. Here, Prior AF = Prior EP – Prior PSAR. For short selling, you may use Prior PSAR – Prior AF to determine the price, where Prior AF = Prior PSAR – Prior EP.

As with any trading strategy, risk management techniques require practice to perfect. There are various parameters that may impact your risk management, including your risk tolerance, typical price movements in your chosen assets, current volatility in the asset, and the current average risk appetite in the market.

Key Takeaways

  • The higher the leverage you’re using, the more powerful your risk management strategy needs to be.
  • Expert traders often combine stop-loss orders and trailing stop for a more robust exit strategy.
  • There are three ways to calculate stop-loss, namely percentage method, technical support & resistance method, and EMA method.
  • Among the best strategies for trailing stop-loss are the percentage method, Average True Range (ATR) and Parabolic Stop and Reverse (SAR).

 

Open a live account with ADSS to trade with leverage and use the best risk management to lock in gains on winning trades.


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Investing in CFDs involves a high degree of risk that you will lose your money due to the use of leverage, particularly in fast moving markets, where a relatively small movement in the price can lead to a proportionately larger movement in the value of your investment. This can result in loses that exceed the funds in your account. You should consider whether you understand how CFDs work and you should seek independent advice if necessary.

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ADSS is an execution only service provider and does not provide advice. ADSS may publish general market commentary from time to time. Where it does, the material published does not constitute advice, or a solicitation, or a recommendation to a transaction in any financial instrument. ADSS accepts no responsibility for any use of the content presented and any consequences of that use. No representation or warranty is given as to the completeness of this information. Anyone acting on the information provided does so at their own risk.