Are stop loss orders applicable to spreadbets? Yes, unlike shares, options or warrants you can place a stop loss order with a spread trade.
But what are stop orders? An order to trade if the price becomes less favourable is known as a stop order. In other words a spread betting stop loss order links a stop loss point or level at a pre-determined price at which you want to get out of a spread trade if it goes against you. These orders are typically used to limit your maximum exposure. You can’t watch the market all days every day – you have a life to live. Also, you don’t have unlimited money to cover your bets, and so cautious people use stop orders to peg their losses at a fixed amount.
A stop loss comes useful to protect you from mistakes (because, let’s face it we are humans and even the best traders make mistakes) or unexpected news – situations you cannot avoid irrespective of the time you dedicate in research and analysis. Stops are particularly useful when you are utilising leverage and you are not able to absord a margin call greater than a certain amount. They also make sense in situations where you believe the majority of the market participants are not behaviting rationally which carries a timing advantage for the early movers
Stop-Loss Orders – Not Foolproof!
Traditionally, investors who buy stocks in a company do so with the hope that they will rise in value. When this doesn’t materialise and the stocks actually fall in value, shareholders lose money. If the investors end up selling the shares for a lower amount than they originally purchased them, they incur a loss and this loss becomes bigger if the stock price continues to fall (until the investors decide to sell).
Stop orders were designed to help protect against losses. But take care! Stop loss orders are not by any means a perfect solution. It is important to keep in mind that a stock could fall below the stop loss level before it can be sold. For instance let’s say that a share opens on Day 15 at $12. The stop loss level of $10 hasn’t been hit so the share remains in one’s portfolio. The next day the share opens at $9 and since this is below the stop loss level, the share is immediately sold – at $9 not $10.
Stop orders are free to place but in volatile market conditions there is a risk that the price will gap through the stop level and fail to trigger the order.
Definition: A stop loss order is basically an instruction to deal at a less favourable level than the present price. It is commonly used to cap the potential loss on a running position and in this respect is generally referred to as a stop loss. Ideally, you should place your stop loss order as soon as you have opened a spread betting position. A stop loss level is usually a small percentage below your entry price if you have a long spread betting position or a small percentage above your entry price if you have a short spread betting trade.
The downside of stop orders is that you are closed out automatically when the price reaches the stop threshold. You have no choice in the matter – your position is closed immediately and you have to make good the losses. There is no difference between a stop order and a stop-loss order. They are the same thing.
A stop loss does somewhat reduce risk and is normally quite effective at this but keep in mind that it is not absolute.
Think of a stop loss as an insurance or a trader’s escape hatch if you believe the stock you are holding is susceptible of further falls.
Example: You bought December FTSE (£10/point) at a quoted price of 3975, expecting the market to rise higher. However, the maximum amount you can risk losing, without it REALLY hurting, is £5000. This is the same as saying: ‘I can only take a 500 point drop in the December FTSE price before I must exit and nurse my wounds.’
You would therefore place the following order:
‘Buy December FTSE, (£10/point) at your quoted price of 3975, stop 3475, good till cancelled.’
This last part is telling the spread betting company to keep the stop order in place until you cancel it. You must remember to cancel the stop loss order. It is not automatically cancelled when you close the bet.
Example: You sold March DOW at 7650 (£20/point). You expect the market to fall big-time, but cannot afford more than £2000 in losses at this time. You are saying: ‘I expect the market to fall, but just in case it rises, I must bail out after a 100 point rise.’ 100 x £20 = £2000, the maximum you can afford to lose.
Your order to your spread betting provider would be:
‘Sell March DOW at 7650, £20/point, stop 7750, good until cancelled.’
They will place a DOWN bet (sell) at 7650, but if the market moves against you (rises) more than 100 points, then he will close you out automatically at 7750, and you will owe £2000, payable immediately.
You should always use a stop-loss when you spread trade. With spread betting you can indeed make money but if the trade goes against you losses can quickly pile up and you could end up battered in seconds. Risk management is very important and if you trade without a stop loss it essentially means that you are not controlling the maximum amount at risk so you would end up losing more than you intended to risk.
Note that a wide stop loss permits you to ride out the short-term ‘market noise’ and allow your position more time to move in your predicted direction. Of course this also means that you could end up with a sizable loss and this is why it is important to scale back your position size to keep the risk to an acceptable level if the market starts keeps moving against you.
In fast moving and volatile market conditions, particularly overnight, it may not be possible to action your stop loss order at exactly the threshold you specified. It is possible for the order to be actioned at a level worse (possibly much worse) than you specified. Anyone concerned could fully protect themselves by using a guaranteed stop when they open their position. For instance, Marks & Spencer shares might close at 390p on Tuesday but re-open the next trading day at 360p after a poor trading update announced on Wednesday morning. You can use guaranteed stop losses to combat market gapping. This normally does not happen, but if you absolutely, definitely do not want to lose more than a certain amount, then you need a guaranteed stop.
The way a guaranteed stops works is that it absolutely caps your stop by closing the trade at a pre-agreed level whether or not the market actually trades at that price. Say, for instance if you had bought £1 per point of the FTSE 100 at 5400 and were only willing to lose £200 on your trading position, you could set up a guaranteed stop loss order at 5200. This means that if the FTSE 100 were to crash and jump to 5120, your trade would still be closed at 5200. Note that not all spread betting brokers offer guaranteed orders and some will only offer them on certain markets.
Remember: Placing limit orders is using the system to your own advantage. Limit orders also close trade automatically if the market rises to a pre-determined target or result in a buy trade (in the case of a short trade) should the market falls to a certain entry point.
Tip: Don’t place stops too tight around the market price. One method is to take hint from the ATR (average true range) of a market which is a measure of the normal average movement of the particular market you are considering over a set timeframe. Set stops outside this range to prevent your stop from being triggered by normal market noise. Stops can also be used to protect profits and aren’t just a means to minimise losses.
Note: Slippage on all stop orders is possible during times when your provider is closed, around fundamental announcements, and times of extreme market volatility. Slippage relates to orders being filled at a price which is worse than the stop price requested by the customer.