Capital Management

CFD trading has become very popular in Australia, following the lead from Europe. However, as Contract for Differences (CFDs) are a leveraged product, there are risks associated with CFD trading. It's advisable that all CFD traders utilise risk management tools as part of their trading plan when CFD trading as they are a geared product. It is important that you always implement a stop-loss level. We often get asked questions about the capital commitment subscribers should use in their trading but this is a question that we cannot answer under our General advice license, you would need to speak to your broker who can offer personal advice.

In this article we will be looking at two different capital management techniques, and discussing what are the positive and negatives of each technique.

Hypothetical Trade List

The following table indicates the hypothetical returns of 27 CFD trades.

Assumptions:

• Starting capital (trading bank) of $10,000.
• Each CFD has a leverage amount of 20 times. (5% collateral)
• Hypothetical example has been constructed with a heavy set of initial losses, with six of the first nine trades failing.

Table 1: 27 trades at 20 times leverage

Application of two different Capital Management levels

Table 2 below highlights the returns based on the above trades by using 2 different capital management.

• Technique 1 - investing a maximum of 10% of capital (trading bank) per trade and
• Technique 2 - investing a maximum of 50% of capital (trading bank) per trade.

Note:

• In both of the above capital management techniques we start off with an initial capital amount of $10,000.
• Column titled 'Technique 1' the total capital remaining after each trade is completed is shown.
• Column titled 'Technique 2' the total capital remaining after each trade is completed is shown.

Technique 1

As stated above, Technique 1 only invests a maximum of 10% of capital per trade. Therefore for the first trade, $1,000 of the $10,000 trading bank will be invested in that CFD trade. After the first CFD trade, $9,528.39 is left in the bank balance and after the fifteenth CFD trade, $10,810.50 is remaining in capital.
 

This technique is obviously a more conservative, however for those who follow the below mentioned paradigm that there is no such thing as a long-term aggressive CFD trader, it is highly recommended.

This hypothetical example has been constructed with a heavy set of initial losses, with six of the first nine CFD trades failing. Nonetheless, employing this strict capital management technique the CFD trader has been able to ride the bumpy times and therefore have capital available as the trades resume back to their more long-term success rate. Notice that after 27 CFD trades the bank balance has risen to $12,284.02.

Technique 2

Technique 2 employs an aggressive 50% of capital per CFD trade rule. For example, for the first CFD trade, $5,000 of the initial $10,000 was invested in it. For example, after the first CFD trade the bank balance left is $7,641.96. At the end of the 27 CFD trades you have only $5,988.70, versus the more conservative CFD trader having a end result that is more than twice as large.

Summary:

The aggressive outlay of capital per CFD trade, as a percentage of the trading bank, is not recommended because if the CFD trader experiences a few consecutively negative trades, they will rapidly lose their capital. A more conservative approach allows for the CFD trader to ride out the rough patches every trader experiences and enables them to trade back to profitability.

This more aggressive technique employed in technique 2 only works when most CFD trades are profitable. In markets where volatility is present the trader is more prone to experiencing losing trades.

As such, in the second 'aggressive technique', the CFD trader has nearly lost all their capital after the ninth trade when the bank balance fell to only $971.31.

There is merit in the saying within the trading world that there is no such thing as a long-term aggressive trader. This discussion may assist those with that mindset.