GK, I am certain that the following discussion is not new to you, but perhaps it can be a reminder.
When trading with leveraged products like CFDs, capital management is the number one priority.
Consider the example where you are considering opening a BHP long trade at the open at 35.53 on 24-Mar-2014. There are several reasons why I would consider opening a trade on this date, but that discussion is not the point of this discussion, which is all about capital management.
Before opening a long trade on 24-Mar, the following factors need to be considered.
How much am I prepared to lose on a single trade.
Where will I set my stop loss.
What is the potential win vs loss ratio.
What will my trade size be.
The following fictitious example demonstrates the key points, but only using long trades as an example. Obviously the converse applies for short trades.
Say my CFD account balance is $100k. I would be prepared to lose $1k on a single trade.
On 24-Mar I would set a stop loss right at the bottom of the previous swing low of 35.06 on 2-Feb-2014.
With a long trade open at 35.53 and a stop loss at 35.06, the potential loss is 47 cents per share.
Based on the BHP peaks on 2-Jan and 20-Jan being around 38.00, a reasonable estimate of the potential gain = 3800 - 3553 = 247 cps. Hence, the win/loss ratio = 247/47 = 5.25. In my opinion this is a very good win/loss ratio, but anything over 3 is good.
Now for the important bit, what will be my trade size. The potential loss is 47 cps as described above. Hence, with a maximum loss of $1k, the appropriate trade size = 1,000/0.47 = 2,128 shares. Normally I would round to an even number, say 2,000 shares. Hence, with this trade size the maximum loss will be 2,000 x 0.47 = $940.
I always use the above process when considering opening a long trade.
A few more points to note.
I am generally not keen on doubling down on a long trade. However, this approach may have some merit if your initial trade is opened at half your maximum trade size, and you only double down once.
I never move stop losses down. In addition, when a trade is showing a reasonable profit I adjust stops every day in order to protect profit, but once I have moved a stop up, I never lower the stop later.
After incurring a bigger loss than you are comfortable with, don't try and trade your way out of the hole with even bigger trade sizes to get 'even' with the stock market. That is, stick with the capital management rules. Say your account balance took a hit and reduced from $100k to $80k. Now you need to reduce the amount that you are prepared to lose on a single trade to only $800.
I could go on, but the above discussion is probably sufficient for now, plus I need to get ready for work anyway.
After recommencing trading in December 2013 I have not incurred a big loss on any single trade. My biggest mistake during the last 6 months came when I was over enthusiastic about a correction and opened 13 short trades in mid-May, which resulted in 4 winners and 9 losers. None of my 9 losses were large, but the fact that the 4 winners were small, and I had too many losers, put a modest but significant dent in my CFD account balance at the time.
