Tips on risk management

Effective risk management is about learning to understand risk and how to build your trading around it. Here our analysts highlight the key factors to risk management when spread betting, and let you know how IG can help you manage your risk best.

It is important to remember that all spread bets carry a risk of failure; there is no reason why a market will move in your favour. When looking at any deal, it is more important to consider ‘how much am I willing to lose?’ than ‘how much am I aiming to make?’.

Prudent risk management, and a disciplined approach to dealing, will help you to weather the run of losses that inevitably occur from time to time. It is only through a structured plan of acceptable risk with an achievable return that an account will be able to grow at a sustainable rate.

1. Understand what you are dealing

It is vital that you understand the underlying product that you are spread betting on, as well as the external factors that will contribute to the speed and direction of its price movement.

Apart from knowing the hours that the products deals in, and the margins required, you will need to look at factors that may affect that market’s volatility. Affecting factors could include currency fluctuations, moves in commodities or economic/corporate announcements on interdependent products. No one bet is totally independent; all are interlinked with a number of other sectors. 

It is an appreciation of these relationships that will give you a better grasp of the market risk.

2. Assess your risk capacity

When entering a deal, you should be looking to make a multiple of whatever funds you deem are acceptable to be lost, i.e. if you are looking to make £300, you should be willing to lose £100. This is called a risk-reward ratio. This ratio is calculated by dividing the amount you stand to lose if the price moves in the unexpected direction (i.e. the risk) by the amount of profit the dealer expects to have made when the position is closed (i.e. the reward). By using a risk-reward ratio you are lowering the percentage of deals that you need to be profitable in order to make money.

3. Use alerts and stops

Once you have researched your market and feel comfortable with the size of your position, it is important to guard against the risk of losing too much money on any one position by setting up an alert or stop, both of which are available on the IG platform. 

Alerts

IG's price alerts will notify you as soon as a level identified by you has been reached, either as an indication to enter a position or as a warning should certain levels be reached on an open position. This allows you to respond to price movements in a way that minimises any losses, while keeping your position open.

These alerts are free to clients on the IG platform and can be sent either as an e-mail or a text.

Stops

If you do not have the ability to closely monitor market movements, or you want to have even more control over your potential losses, a stop could be more advisable. 

Stop losses are a mechanism that allow you to set a pre-defined level at which your bet will be closed automatically should the market move against you. An ordinary stop, which carries no charge at IG, can be added to your deals before you open them or by editing an open position. It is susceptible to the vagaries of the market and will be closed out as soon as is possible, i.e. during market hours only, and if the market suddenly gaps beyond your stop level, it is possible your position will be closed at a worse level than requested. This is known as slippage

A guaranteed stop will close your position regardless of market condition, with no risk of slippage, putting an absolute limit on your potential loss. You can add a guaranteed stop when you place a new deal but you can’t currently attach them once a trade is in progress – this functionality is coming soon. They are subject to an additional charge if triggered. A guaranteed stop is very much like car insurance; it may feel like an unneeded extra cost but, if you do come to rely on it, you’ll be glad of the investment.

IG also offers the ability to implement a trailing stop. This enables your stop to move higher as your position climbs higher, while still maintaining the same stop distance should your position start to reverse. It is designed to protect your profit, without you having to continuously monitor your position and adjust it manually.

It is worth considering that using a trailing stop will significantly alter the risk-reward ratio, as there will be a greater chance of the position being closed out prior to it hitting your ultimate target. This will change the percentage of deals that you will be required to judge correctly.

4. Track your open positions

The IG platform offers ‘Open positions’ and ‘Working orders’ windows, which give you a quick and easy snapshot of your open deals and the running profit and loss.

5. Consider reverse engineering

It is invariably prudent to look at reverse engineering your spread bet – this means starting at your stop and deciding at what level you would admit that you the envisaged market move that you were hoping for is not going to materialise. Once you have been able to ascertain this you can then look at what contingency action you will put in place.