David: A question has been sent in: I’d like to hear your thoughts on placing stops on leveraged trades either shares or margin or CFD compared with an unleveraged trade. If for example for an unleveraged trade, you followed a system where the risk has no more than a certain percentage of your total trading capital on any given trade and place stops accordingly, what are your thoughts on how this strategy might change when using leverage?
If you applied the same system in a leveraged trade considering only the margin component as being your own capital, the stop would be much tighter, increasing the likelihood that you would be stopped out as a result of a comparatively smaller dip in the share price. Alternatively if you set a stop a fixed percentage away from the trade value you will avoid the potential issue but leave yourself exposed to higher leverage and loss.
I suppose the question is how it works setting stops on leveraged instruments. Can you take the same strategies and methods you are using in unleveraged instruments?
Stuart: People may want to step up to the next level and include leveraged trade, and CFDs are a great way of doing it. There are certainly other ways of doing it like options and the like.
What do we do? Do we tighten our stops or do we leave them where we would normally? To me trading leverage you’re trading a very short term approach. I do know people who trade CFDs for the more medium to longer term. The key advantage of CFDs over options is there is no time decay. With options you have a life. With CFDs you don’t have a life.
But for most people when they do trade leverage and trade CFD they do use it on a very short term approach. Generally speaking our stops for short term trading are quite close anyway. That just means that our analysis and our trade execution and our timing and getting in at the right time at the beginning of a short term trend really become quite critical.
Because our stops are so tight, we are certainly increasing the chances of our being stopped out. We are increasing the likelihood you’ll be stopped out because you will be so much closer to the price. To me this all boils down to being a balance because if we have our stops where I think they should be, you know really nice and tight, just a little under the lows of the day for our short term approach, yes you are increasing the likelihood of being stopped out. But good execution, good trade entry, good timing of that and good analysis can reduce that probability.
Or we just get away from the action, we move away from the price we move out of the short term trend, place our stock a lot further away. So yes we’re probably increasing our chances a little bit that we don’t get stopped out, but when you get stopped out you get belted.
So you are really probably adopting a more medium approach where when the short term trends end in a few days and then comes back down you still want to be in the leveraged trade. Because then you want to reverse and continue on a short term uptrend again for the next week, come back down again and then continue higher. So you need that profit to be substantial to overcome again the losses that you will take should you get belted in a more medium approach and getting stopped out.
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