Smart trading: how to manage risk and maximise profit in uncertain economic times

By Dáire Ferguson, CEO at AvaTrade 

The past year has seen demand for retail trading sky-rocket, with record numbers of new traders signing up to profit from the remarkable volatility the financial markets have seen. While trading in such periods presents the opportunity for traders to win big, it is perhaps more pertinent than ever for participants to ensure they have a proper understanding of the industry – not least when it comes to managing risk. Dáire Ferguson, CEO at AvaTrade, explains

2020 is a year that none of us are likely to forget in a hurry. Alongside fundamental changes to our everyday lives, the coronavirus pandemic saw the financial markets experience unprecedented turbulence, putting an end to a sustained period of global growth as the stock markets crashed early in the year. With companies’ stocks seemingly on board a rollercoaster (some of which have yet to get off) and members of society unable to leave their homes for sustained periods, it is of no surprise that vast swathes of people turned to the stock market in the hopes of making a quick buck.

Many have profited during this period – and not just financially. Retail trading enables individuals to learn an exciting new skill and join a community, something that has been hard to come by in an increasingly fractured world. What’s more, with interest rates on regular savings accounts presenting little to get excited about, delving into the world of trading presents an enticing alternative for those looking to grow their savings.

Risk vs reward: a fine line

Of course, profiting when trading is not a given, and understanding the markets and how to navigate them is fundamental to success. Trends such as the GameStop short squeeze perfectly represent the high-risk, high-reward nature of trading – with sudden price movements providing tantalising opportunities for huge profits. Yet such events can just as quickly result in crushing losses, and for new traders not armed with the knowledge of how to carefully manage risk, this can prove devastating.

By developing a solid understanding of the markets in which they are trading, the assets they are investing in and the various options at their disposal, traders can ensure that they are not only making informed decisions regarding their trades, but that they are managing their exposure to risk. In doing so, they can ensure unnecessary losses are avoided and ultimately, that they will have a more enjoyable trading experience.

Getting started

The first decision new traders need to make is which platform they use. Choosing a broker with ample regulation, an established market reputation, a range of risk management tools and the right instruments available on their platform is a vital first step and will render the trading experience both easier and – most importantly – safer. Many brokers will offer a demo account, which will give potential customers the opportunity to test run their platform and ensure its features suit their needs.

Next, a trader must decide the type of trading they wish to undertake. Purchasing outright assets – for instance, on the stock market – gives traders the opportunity to own a percentage of a company, or to fully own certain assets. Alternatively, contracts for difference (CFDs) enable traders to purchase a contract that tracks the value of an asset. The trader simply receives a profit or loss based on the price movement of the asset, rather than taking physical delivery.

Finally, a trader should consider the markets they wish to trade in, and how each of these differ. From foreign exchange (FX), to stocks, to commodities, there are a multitude of different options available, each presenting their own nuances and benefits, as well as diverse risks that it is important for traders to be aware of. FX, for instance, is subject to small, regular, daily fluctuations and is highly sensitive to news triggers, while commodities are largely driven by supply and demand.

Managing risk

Having a solid understanding of the markets and assets available is important to laying a solid foundation when beginning a trading journey. Yet even the most experienced traders can fall foul of unexpected market movements. There are several techniques that can be employed that ensure risks are controlled.

A simple and often overlooked way of controlling risk is by managing the capital-to-trade ration, which is the amount of capital left exposed to losses in trades compared to the total amount available. A sensible rule is to not exceed a ratio of 5-10% – and not to risk more than 2% of capital on one trade.

Another straightforward tool is to set up “take profit” and “stop loss” orders alongside a trade, which enable you to automatically close an open position at either a predefined rate of profit (i.e. once it reaches a certain point above the current market price), or to sell the position at a pre-defined rate below the market price, in order to minimise loss.

In addition to the above, certain brokers have enhanced risk protection offerings that allow users more solid protection against losses. Our risk management tool, AvaProtect, for instance, enables traders to purchase full protection against losses for a predetermined timeframe. If, at the end of the period of cover, a loss has been made, the full amount of the trade is reimbursed. While such tools minimise downside risk, there are no limits to the maximum value of the trade, enabling users to benefit from higher levels of volatility without ending up out of pocket. Another advantage of this type of protection is that it allows the user to ride out any shorter-term fluctuations during the trade.

This is an exciting time to be trading and opportunities certainly remain plentiful as certain regions and sectors begin to emerge from a period of heightened volatility. While this continues to create opportunities, as always, the market can move in the wrong direction. As such, it is of paramount importance for users to ensure they are making the most informed decision possible and taking steps to protect themselves.