By Dáire Ferguson, CEO at AvaTrade
Over the course of the past year, the market for retail trading has soared. In an attempt to profit from the extraordinary volatility that has been observed in the financial markets, record numbers of new traders have emerged. While it cannot be denied that trading at this present moment in time presents a fantastic opportunity for traders to make substantial financial gains, it is vital to have a sound understanding of the industry, especially in terms of managing risk.
The events of 2020 won’t be forgotten anytime soon. The Covid-19 pandemic has fundamentally changed how people go about their everyday lives, with individuals wearing masks when outside their homes and employees having to work remotely for the past 18 months. What’s more, the pandemic also resulted in the end of a continued period of global growth as the stock markets collapsed in early 2020. As business stocks continue to seesaw and people remain at their homes for a prolonged period of time, it is unsurprising that large numbers of individuals have turned their attention to the stock market in an attempt to make a quick financial gain.
Traders have been able to profit during this time frame, and not just from a financial point of view. Retail trading presents people with an opportunity to gain an understanding of a fascinating new skill and become a member of a community – something that has been harder to do in recent years due to the increasingly fragmented world we’re currently living in. Furthermore, with the current interest rates on standard savings accounts being very low, around 0.60 percent annual percentage yield, taking a chance and delving into trading presents individuals with an enticing alternative should they wish to grow their savings.
The fine margins between risk and reward
It is vital for new traders to understand that profiting when trading is by no means a guarantee, with some level of understanding regarding the markets and how to traverse them required to succeed. For example, the GameStop short squeeze perfectly illustrates the risk-reward nature of trading, with abrupt price movements giving way to mouth-watering opportunities for large amounts of profits to be made. However, events like this are just as likely to lead to crushing losses. This can be devastating for individuals, particularly those who are unaware of what they need to do when it comes to managing risk.
So long as traders develop a solid level of understanding regarding the financial markets in which they are operating in, as well as take the time to learn about the assets they wish to invest in and the different options available to them, they can ensure well-informed decisions are being made concerning their trades. Moreover, traders are also controlling their exposure to any potential risks, making sure that any unnecessary losses are circumvented and ensuring a trading experience which is to their liking.
How to begin
When it comes to trading, the first item on the agenda for new traders to decide on is which platform they would like to use, finding a trading experience that is easy, safe and secure. The majority of brokers offer risk-free demo accounts, presenting first-time users with the opportunity to trial their platform and ensure it has all the necessary features to meet trading requirements.
Following this, a trader needs to decide which form of trading they wish to partake in. For instance, traders may wish to purchase a contract that monitors an assets value – known as contracts for difference (CFDs). This means the trader receives a profit or loss depending on the price fluctuation of the asset, as opposed to taking the physical delivery itself. Alternatively, they may want to purchase outright assets on the stock exchange. Buying the asset outright enables traders to own a share of a business, or to own certain assets fully.
Lastly, it is vital for traders to think about the markets they wish to operate in, and the differences between them. Whether it be commodities, foreign exchange (FX) or stocks, there are numerous distinct options at the disposal of traders, with each one presenting their own unique benefits, in addition to diverse risks that participants must take into consideration. For example, commodities are predominantly determined by supply and demand, while FX is subject to small but regular movement and is extremely sensitive to news triggers.
By having a sound understanding of the assets available and markets, traders will have a foundation in place when starting their trading journey. Nevertheless, even experienced and highly knowledgeable traders can fall victim to unexpected fluctuations in the markets. To successfully manage risks, there are a number of techniques that can be used.
A straightforward tool is to establish “take profit” and “stop loss” orders in conjunction with a trade. Doing this allows traders to automatically close an open position, whether it be at a predefined rate of profit, or the position is sold at a predetermined rate below the market value so as to minimise any potential losses.
Another simple yet often overlooked way of managing risk is to control the capital-to-trade ratio. This is the amount of capital which is left exposed to losses in trades versus the total amount available. Ensuring a ratio of five to 10 percent is not exceeded is a sensible rule.
Further to the above, some brokers have heightened risk protection offerings that provider traders with greater protection against losses. For example, at AvaTrade our risk management tool, AvaProtect, enables customers to purchase full protection against losses for a predefined period of time. If a loss has been made during the timeframe for the cover, the user is fully reimbursed for the full amount of the trade, minimising downside risk. Nevertheless, there are no limitations when it comes to the maximum value of the trade, meaning customers are able to benefit from high levels of volatility without having to worry about being out of pocket. An additional advantage of protection like this is that it gives users the chance to ride out any short-term variations observed during trades.
It cannot be denied that the present moment is an exciting time to be trading, with opportunities in abundance as industries and regions start to emerge from an extended period of intense volatility. Although this continues to produce tantalising possibilities, the market always has the potential to move in the opposite direction. Therefore it is vital for traders to ensure they are utilising the information and tools at their disposal in order to take the necessary steps to protect themselves and make an informed decision.