Risk and Stop Losses

It is virtual when when you trade on leverage you have protection against large market moves against you. When placing a spread bet, spread traders should always think about when to exit if things don’t go to plan. Stop loss orders are an important risk management tool that you can set to help you protect your trading capital in case the market moves against your trade. Most spread betting providers provide a number of risk management tools to help you manage your risk including stop loss, Limit, If-done and One Cancels Other (OCO) orders :

  • Stop Loss: Manage risk by applying a stop loss to your spreadbet. This will place a close order when your noted price is reached, closing the bet automatically. If the market price touches your stop loss order, then the order will be executed and you will be exited from that spread trade. Stop losses are free to use and can be edited or removed at leisure.
  • Guaranteed Stop Loss: In fast markets prices can ‘gap’ through stop loss levels. No matter how great and fast the markets move, securely lock an exit price, with a guaranteed stop loss. Please note a small fee is charged for this service.
  • Trailing Stop Loss: If not in front of the screen, set a trailing stop loss to automatically risk as the market price improves, minimising risk and locking in profits with no effort required.

The difference between normal stop loss orders and guaranteed stop is best explained by an example. Foor a normal stop loss order to be executed the market must actually trade at your nominated stop loss price, say 240p. However, market may gap, which in practice means that the price can jump from one level to another, say overnight from 255p at the close of trading, to opening the following day at 231p. Since the market never traded at your 240p stop loss price your spread trade would be exited at 231p on the opening session. For your stop loss order to be executed at 240p your order would have to be guaranteed. There is a nominal extra cost to use guaranteed stops but there is no cost for placing normal stop loss orders.

Normally most providers also make available ‘If Done’ (contingent orders). Many spread traders think about where they want to take profits or close out before placing their bets. ‘If done’ orders offer the ability to add targets and stop loss orders to opening bets. The key advantage of this is that a trader could place a bet and leave it running in confidence, knowing that if their target price is reached, profits will be taken automatically.

Stop Losses. The Superheroes of Spread Betting

Most people know two things about spread betting: you can lose a lot of money, and you can lose it fast.

True enough. But what doesn’t receive much attention is a simple but powerful tool that can protect traders from the sort of losses that hit the headlines.

They’re called stop losses.

A stop loss is a financial safety net that limits your losses on a trade.

If the market doesn’t go the way you expect it to, your stop loss will rescue you before your loss burns a hole in your account. Stop losses are critical to successful trading. Incredibly, not all traders use them.

How a stop loss works

The purpose of a stop loss is to prevent big losses.

Let’s say you go long on the DAX 30 Rolling Daily at 6,200 for £1 per point. You’re betting the DAX will climb. But if you’re wrong and the DAX falls, you don’t want to wait too long before you admit defeat and exit the trade!

So you set your stop loss at 6100 – 100 points below your entry point of 6,200.

Now, the maximum you can lose is £100.

The DAX starts off well, climbing to 6,275, but then it falls back to your entry price. It hovers there for a few hours, not doing much, before diving to 5,900 as the markets close.

Without your stop loss, you’d have lost £300. But thanks to your precautions, the system closed your position when the DAX hit 6,100 and you only lost £100.

You still lost money. But just like in poker, spread betting is all about maximising your winnings and minimising your losses. You should set up a stop loss on every trade you make. If a huge downswing hits when you’re away from your computer you’ll escape a catastrophic loss.

Warning!

Many traders don’t set an automatic stop loss when they execute a trade.

Instead, they use a ‘mental’ stop loss. They’re basically promising themselves, “I’ll get out if things get too sticky”.

Can you see the problem here? It takes great discipline to not adjust your stop loss when it’s about to be triggered.

“I’ve lost £30, so what’s another £10? I just know things will turn around after lunch!”.

No! Set an automatic stop loss and stick to it.

You should set up a stop loss on every trade you make. If a huge downswing hits when you’re away from your computer you’ll escape a catastrophic loss.

But besides limiting your losses, stop loss can also help you to lock in profit on a trade. When a trade goes your way, you can inch your stop loss to follow it, guaranteeing that if the trend you’re following reverses you’ll still escape with some winnings. It’s called a trailing stop loss.

Let’s look at an example!

1) We open our trade.

The FTSE100 is at 5,176.50 and we’ve gone long at £1 a point. (For every point the FTSE100 climbs we gain £1, and for every point it falls we lose £1.) We set our stop loss at 5,126.50. If the FTSE 100 slides below that, the system will sell and we’ll exit the trade £50 worse off.

2) We move our stop loss to lock in our profit.

Fortunately the FTSE100 soon climbs to 5,326. Right at that moment we have a profit, on paper, of £205.50p. But if it falls we could lose our profit. The answer? The stop loss! We move our stop loss up from 5,126.50 to 5,300.

Now, if the FTSE 100 falls back below 5,350, we’ll automatically sell and take a £123.50 profit. However, if it continues to rise, we’ll continue to earn.

3) We lock in still more profit The FTSE100 continues to climb. Soon it’s at 5,425. Now our paper profit is £248.50. (Remember we bought at 5,175.50 for £1 a point.) Again, we move our stop loss upwards to 5,420, locking in at least £243.50 profit.

4) Market falls, our stop loss is triggered

And it’s a good job we did! The FTSE100 begins to fall, eventually dropping back to 5,262. But our stop loss kicks in – exiting the trade for us at 5,420.

We’ve made a profit of £243.50, thanks to our friend the stop loss.

Locking in profit is a key concept of financial spread betting. You should always be looking for chances to lock in profit.

Are Stop Losses Guaranteed?

Now you understand what a stop loss is, and why it’s important to use one. One of the things you should be aware of is the following:

Markets can move quickly. Sometimes there’s a panic, and the market falls or rises too quickly for your stop loss to be executed.

Unfortunately, stop losses are not guaranteed. Normally a stop loss is traded close to what you ask for, give or take a few points.

But it’s important to be aware of what can happen if panic sets in.

P.S. If you really want to be safe…

There are special type of stop losses you can set up that DO guarantee to honour your stop loss – even if the market’s moving too fast for the system to execute it.

The Guaranteed Stop Loss (GSL) costs you more money, so you should only use it if you’re executing a very risky bet.

Most people hardly ever use a GSL, but it’s good to know they exist.