Spread Betting With A Guaranteed Stop Loss Order

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Written by Justin Grossbard

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We take a look at what a guaranteed stop loss order is, how they work, and how much they cost. We also look at whether they are more beneficial to the trader than using traditional stop losses.

CONTENTS

Guaranteed Stop Losses Orders (GSLO)

A guaranteed stop loss is similar to a traditional stop loss but whereas a normal stop might suffer from slippage, a guaranteed stop as its name suggests guarantees a certain exit price.

Slippage is the difference between where a stop loss level is placed and where the actual order is filled.

For example, if you enter a stop (not guaranteed) to sell £2 of the FTSE at 4300, the actual sell price might be 4297, and the 3-point difference is slippage. More information on slippage is on the main Stop Loss page.

But is slippage that much of a problem, or is it just one of the negatives of trading that every trader, whether large or small, has to accept?
Whatever your view, the Spread Bet brokers offer their clients a way to eliminate slippage once and for all, in the form of what’s called a guaranteed stop loss or, as some Spread Betting companies call it, a controlled risk spread bet.

a guaranteed stop loss order helps prevent losses

 

How a guaranteed stop loss order works

Think of a guaranteed stop as an insurance policy, and of course, there is always a price for insurance. For example –

  • You’re quoted the FTSE at 4230 – 4232
  • But you’re worried about slippage because the market is volatile so decide to use a guaranteed stop-loss
  • However, when you deal, a premium is added to the quote, so now the spread becomes 4226 – 4236
  • The 4 points added and subtracted from the original quote of 4230 – 4232 is the insurance cost for the guaranteed stop loss

4 points on the FTSE doesn’t sound like a large amount of money but do enough of these trades, and unless you’re a truly exceptional trader, it’s going to be extremely hard, if not impossible, to make money over time.

The downside to guaranteed stops

1. The insurance is paid upfront

You pay upfront for the cost of the guaranteed stop loss, even if it’s not needed. For example –

  • You buy £5 of the FTSE at 4232 (+ 4 points of insurance), so your actual dealing price is 4236
  • The market rallies 50 points, and you sell out for a juicy profit
  • So the insurance cost of 4 points wasn’t needed, and theoretically, the money has been wasted (with hindsight of course)
  • If you think about this, it’s an incredible advantage to the spread betting firm, and it’s no wonder many of them try to push guaranteed stops so much

2. Guaranteed Stops can be expensive

In the FTSE, the costs are about 2-4 points, and with shares anywhere from 0.3% – 0.75% of the size of the deal and believe me, those costs, whereas they look relatively small, are a massive handicap to pay.

Don’t believe anyone who tells you that guaranteed stop losses are not that much and are worth the cost. Either those people have an interest in selling them or they don’t know what they’re talking about.

As I have indicated many times on this site, the cost of doing business is an incredibly important factor to pulling profits out of the markets over time, and it’s not all about buying and selling at the right prices, although that helps! So ignore costs at your peril.

3. Professional traders hardly ever use them

If there’s one group of traders who know the important and dominant role that costs play when trading and investing it’s the professional traders. So you won’t find them using guaranteed stops and that speaks volumes.

The professionals will probably approach the markets like this –

  • They realise that slippage is part of the trading game, but 95% of the time it won’t be a problem, perhaps 1-2 points in the FTSE maximum
  • But there will also be countless times where there’s no slippage when stops are activated
  • Yes, a few times a year slippage will be a problem but by not using guaranteed stops they will have saved a fortune and it’s that money that will be used to pay for the excess slippage
  • In effect, they have self-insured their stop losses and probably saved a fortune as well

4. They’re designed for beginner traders

Never discount the power of scare marketing, we witness it all the time.

For example, the Vitamin industry regularly uses it – if you don’t take your daily vitamins, then there’s a high chance you’ll be in poor health and die early etc. OK, I’m elaborating somewhat, but you get the point.

And scare marketing is probably used to push guaranteed stops as well focusing on the fact it’s possible to lose more than you expected if some major news/event hits the markets. That may be true, but it’s not going to happen as much as perhaps they suggest.

When to use a guaranteed stop

Just because they’re expensive and bad value doesn’t mean we as responsible traders shouldn’t use them. I, for example, would definitely consider using them in certain situations, such as –

  • If I were to trade an unusually large position – If my trading size in the FTSE is traditionally in the £2 – £7 a point range and I take a position of £30 a point or more that’s a lot of risk should the market move quickly against me. So a guaranteed stop loss is worth considering
  • When the markets are exceptionally volatile – Slippage is a way of life for the trader, and it’s no problem if relatively small. But slippage can be a major problem when the markets are exceptionally volatile, so again, I would consider using a guaranteed stop

CompareForexBrokers Comment

Whereas guaranteed stop losses must be welcomed into the trading arena, they offer more flexibility after all, it’s my view that they’re more about making profits for the spread bet brokers than anything else.
They’re often heavily marketed to new traders whereas professionals hardly if ever use them, and that should tell you everything you need to know.

So don’t be scared about slippage it’s not really a problem unless the markets get super volatile. My advice – just use regular stop losses.

Stop Losses: What are they – How to use them

We look at what stop losses are, how they’re used, and the advantages they carry in limiting losses and therefore preserving capital.

It is important to realise that using stop losses with products like spread bets that offer leverage is critical. To be successful in trading leveraged products, you’ve got to respect potential risk, and that’s what stop losses are all about.

Note: Although this guide is on the Spread Betting part of the website Stop Losses follows the same principles for all the markets, whether CFDs, Options, Stocks or Futures etc.

As the name suggests, a stop loss order is an order designed to limit a loss to a certain level.

It is an integrated part of spread betting, in fact, any financial product that uses and offers leverage. For example –

  • You buy the FTSE 100 market at 4230, expecting it to go higher
  • To limit your loss in case the market collapses, you enter a stop-loss order to sell your position at 4200
  • The stop loss order will only be activated should the FTSE fall below 4200
  • In this example, the market does move lower, and as it breaches the 4200 level, a market sell order is executed at the market price

On the whole, stop losses are easy to understand; just think of them as market orders that are activated only if a certain price is hit – more information on the different types of orders

And because spread betting allows a trader to go either long or short, a stop loss can, in turn, be either a buy or a sell order. For example –

  • You are short £2 of the FTSE 100 at 4230, expecting it to move lower
  • You enter the stop loss order of buy £2 at 4250 on a stop loss
  • The order won’t be executed if the market doesn’t trade higher than 4250
  • But assume it does, and so the £2 short FTSE position is covered (bought back) for a loss

Slippage – It’s important to understand

Stop losses work in a similar fashion to a market order, but they are held back until a certain price point is breached. A market order, discussed in more detail on the orders guide, carries both an advantage and a disadvantage –

  • Advantage – guaranteed fill: if you enter either a market buy order or sell order, you’ll always trade at some price
  • Disadvantage – the price you deal at might not always be to your liking. Perhaps the market is extremely volatile, and prices are jumping around all over the place

An example of this would be the important economic figure that’s published every month – US Non-Farm Payrolls (their unemployment figures). These are often hotly anticipated, and if a shock number is released, markets can go haywire.
The FTSE for example can easily move in a 50-point range in under a minute. It’s not always that severe, but it has happened many times in the past.

The point is this – a stop loss order only gets activated as it moves through a certain point, and when it does, it becomes a market order. And if at the precise time (as it moves through the stop loss level) the market is volatile the price where the actual order is transacted might be different from the original stop loss level. For example –

  • You are long £1 of the FTSE at 4230
  • You put in a stop-loss order to sell £1 FTSE at 4200
  • As the market breaches 4200, a market order is activated to sell £1 at the current market price
  • At the same time, an unexpected economic report is published, and a tsunami of sell orders hits the market at once
  • As there are not enough buyers, the price drops immediately to 4190, and that is where your stop loss is filled
  • And this 10 point differential (4200 – 4190) is called slippage, and you must understand it

1. Slippage is a way of life – get used to it

Nobody likes slippage, but –

a) you don’t always get it, and
b) it’s not often that bad, perhaps 1-3 points in the FTSE, but it does depend on many factors such as –

  • How volatile the market currently is
  • Whether the market is devouring any news, perhaps an economic figure
  • How liquid the current market is, for example, the FTSE is very liquid at 4 pm, not so liquid at 4 am
  • How many other stop losses there are at the same level

If you’re new to spread betting, don’t get worried about potential slippage on your stop-loss orders. You cannot be a trader without it – it’s a fact of life whether you’re the smallest trader in the market or the largest.

OCO orders and Stop Losses

  • These can be used in combination with stop losses. For example –
    • You are long £2 of the FTSE at 4230
    • You enter a limit sell order at 4270 combined with a stop loss order at 4210
    • The idea is that you’ve got both bases covered: if the market rallies, you’ll sell out at a profit; if it declines, the order will be sold via a stop loss
    • So whichever order gets filled, the other is automatically cancelled hence OCO (One-Cancels-Other)

A similar OCO order can be used to sell out on the close of business –

  • You’re short £5 of the FTSE 100 at 4200, expecting lower prices
  • The market is drifting lower in the afternoon, and instead of entering a limit buy order to cover your short, you decide to cover it on the close using a MOC (market on close order)
  • But you still want a stop loss in place to cover the trade at 4210 should the market rally
  • The order would, therefore be to buy £2 of the FTSE at 4210 stop OCO MOC
  • Or, in plain English, buy £2 of the FTSE on stop at 4210 or on the close, whichever happens first

And there’s even an order which consists of 3 separate orders –

  1. A limit order
  2. A stop-loss order, and
  3. An MOC

For example –

  • You’re long £2 of the FTSE at 4230, expecting prices to rally
  • You enter a limit order to sell at 4260 + a stop loss order to sell at 4200 + a market on close order (MOC)
  • The order would, therefore be to buy £2 FTSE at 4200 OCO 4260 stop OCO MOC
  • Or, in plain English, buy £2 FTSE at 4200 or 4260 stop loss or on the close, whichever happens first

Stop-loss orders are not always about taking losses

Finally, a stop-loss order can be used to initiate a new position or, as discussed in the next heading, to protect a profitable trade.

Traders often use momentum to determine whether they should go long or short the market and will then often use stop-loss orders to enter into a new position. They use the argument that a market often gathers pace when it starts to move one way or the other.

Their strategy is, therefore, to go long into strength or go short into weakness, and if the market does neither, they stay out. For example –

  • The FTSE is trading at 4200, and your analysis suggests if it moves through 4230, it’s got a great chance of hitting 4300, but if it stays trading below 4230 you don’t want to get involved preferring to sit on the sidelines
  • Your order would then be to buy £5 of the FTSE at 4230 stop
  • If the market rises past 4230, the stop loss order will get executed at 4230 + any slippage
  • So, although you’ve used a stop-loss order it was to initiate a new long position

Stop-loss orders can also be used to protect built-up profits

For example, if you bought the FTSE at 3700 and it’s now 4200, which is a hell of a lot of open profit.

Who says the market can’t rally another 200-300 points? But if it doesn’t, you place a sell-stop loss at 4125, so if the market does decline, you’ve still bagged an excellent return.

In these situations, traders will often use what’s called a trailing stop loss – see below for more details.

Summary – Some of those orders might be a mouthful, but they’re easy to understand. They might not click at first, but if you take your time, you’ll soon get on top of everything.

The different Types of Stop Loss Orders

So now you know what stop losses are and how they’re executed, where do you place them, i.e. at what price levels? Sadly, there is no one-size-fits-all answer, but here are some ideas.

1. Money Stop Losses

The simplest stop losses are money stops, where a fixed amount of cash is at risk. For example –

  • You go long £5 of the FTSE at 4230
  • You decide to risk £100 on the trade
  • So enter a stop loss order to sell £5 FTSE at 4210 (4230 – 20 = 4210)

2. Percentage Stop Losses

Percentage stop losses can either be a percent of where the market is currently trading or a percent of your trading capital. For example, if using a percent of where the market currently is –

  • If you go long the FTSE at 4200 and enter a 1% stop loss – that would be at 4158 (4200 x 0.99)
  • If you went short the FTSE at 4200 a 3% stop loss would be at 4326 (4200 x 1.03)

However, as spread bets use leverage even a 1% or 2% move against your current position can result in significant losses. This is an important point.

So when using leverage many traders will prefer to use a percentage of their trading capital, usually in the 1% – 5% range. Assume you’re risking 3% for this example –

  • Your account has a balance of £5,000, 3% of that is £150
  • You buy £2 of the FTSE at 4200 and so the stop loss order is placed at 4125 (75 x £2 = £150)

3. Technical Stops

Personally, I like technical stop losses the best. This is where the stop level is placed above or below a certain chart point. Now, you may or may not like charts, but they are useful for gauging market behaviour.
Daily Vodafone Chart

The daily chart above is of Vodafone. The low of the recent move was 112p. The theory is that as 112p found support before probability states, the level should find support again.

But the stop loss level shouldn’t be at 112p, rather it should be somewhere below this level to give the market some room to move. If it was me placing the stop loss I’d probably put it at 108p-109p.

Basically technical stops have some price relevancy built in, ie they’re based on what the market has been doing. This is in contrast to pure monetary stops which are placed at arbitrary price levels.

4. The recent high/low stop loss

As the name suggests these stop losses are placed above or below the recent high or low, perhaps for example yesterday’s low or even today’s low if you’re day trading.

The reasoning behind these stops is similar to technical stops explained above. If a market has found support, ie excess buying at a certain point, then probabilities state it will do so again.

Again, how many points above or below the recent high/low should the stop be placed at?

This depends on many factors such as what the market is, how volatile it’s been and possibly any forthcoming news. If it was the FTSE and in normal market conditions then a practical level would be 5-10 points above or below the high/low.

The dangers however of both technical stops and using the recent high/low is that these levels are also where many traders place their stops. This is why sometimes you’ll see a market go crazy around one of these price points as many stop losses orders get hit at the same time. In such a case your stop loss might be filled with more slippage than normal.

Longer-term traders can also use recent highs and lows for guidance in stop placement. But instead of using the previous daily low, why not use the low of the previous week or month? This is normally a far better place to put your stop than a fixed percentage or monetary amount because again you’re letting the market guide you.

5. Trailing Stop Losses

A trailing buy stop loss is where the stop level moves higher as the underlying market moves higher. Conversely, a trailing sell stop will move lower as the underlying moves lower. For example –

  • If you go long the FTSE at 4200 with a 25 point trailing stop loss, the stop level is 4175
  • If/when the FTSE moves to 4201, the trailing stop also moves up by a point to 4176
  • If/when the FTSE moves to 4210 the trailing stop level moves to 4185 and so on

Trailing stop losses are normally used to protect a profitable position and are hardly ever used to take out a new position.

6. Breakeven Stop Losses

A break-even stop is a stop loss order that is placed at the same level as where the original trade was transacted. For example –

  • You buy the FTSE at 4230 and it shoots up to 4250
  • So far it looks like a good trade and you fully expect the market to continue to rise
  • But you don’t want a good winning trade to end up losing so you place a stop loss to sell the position at 4230, your original entry price

But you want to try to get some balance on how far the market should move in your favour versus placing a break-even stop loss. For example, if you buy at 4230 and the market moves to 4235 a breakeven stop of 4230 would have a high chance of being executed. Traders therefore use them when the market has made a reasonable move in their favour, in the FTSE probably at least 20 points if not more.

7. Tight stop losses versus wide stop losses

This is an argument that has been going on for as long as stop losses have been around, and unfortunately, it will never end as there’s no right or wrong answer.

The question is this – is it better to use a tight stop loss (one that’s near to where the position was opened) or a wide stop loss (one that is far away). An example, assume you bought the FTSE at 4200

  • Tight stop loss level – 4190 (10 points)
  • Wide stop loss level – 4150 (50 points)

Both have good and bad points.

The tight stop loss, at 4190, will lose you the least money but at the same time has a high chance of being hit as it’s only 10 points away. The markets obviously never move in a straight line so it’s possible you buy the FTSE at 4200, the market drifts lower to 4188 activating your stop loss, before rallying sharply to close at 4275.

The wide stop, at 4150 has far less of a chance of being hit. But if it is, the loss of 50 points will be relatively large. However, if the market sells off (after you’ve gone long at 4200) to 4185 before rallying sharply to close at 4275 clearly the wide stop was better, with hindsight of course.

Some tips on using a stop-loss

To get the best out of a stop loss does require understanding when it is best used. Here are some tips:

1. Timing has to be considered when using a stop-loss

So which stop is better, tight or wide? It’s hard to answer but on the whole, I would think that wider stop losses are better because most traders struggle with their timing. We might for example forecast the FTSE 100 points higher over the next 2 days but in fact, it takes 5 days. So with a wider stop loss, we give the market more room and time to move.

Clearly, though there has to be some balance struck towards how you trade the market.

If you’re shooting for small and quick profits then tighter stops are normally better. But if trading weekly or even monthly moves wider stops are generally better. Yes, you’ll lose more when wrong but then longer-term positions should provide more profit as well.

Summary – When many people start trading spread bets the temptation is to use stop loss levels that are too near to where the current market is trading because they believe the risk is smaller. But they often forget the percentage chance of the stop loss level being hit is high.

One way to confront this problem is to initially use a wide stop when you first enter the market and then move the level as the trade evolves. For example –

  1. You go long the FTSE at 4200 with a view to holding the position for a few days thinking there are at least 100 points of profit available
  2. Place your initial stop loss at 4150
  3. Then, later in the day as you get a better feel for how the market is trading move the stop level higher
  4. And with online trading, this is as simple as a few mouse clicks

2. Experience is Important when Placing Stops

This guide has shown there is no exact science when figuring out the level to place a stop loss. Sometimes many factors come into play and experience is often the key when deciding the right level to place them. Perversely you will find that you learn a fair amount by putting your stops in the wrong place.

While this is not good news in the short term it’s often good news over the long run. Learning from your mistakes, assuming you do learn from them, is the best education a trader can receive.

The main error people make when first using stops is to place them too near to where the market is trading. If you want to cut down on the number of errors that you make when you start out, then try to place your stops far away from the current market price, giving the market plenty of room to naturally move around without stopping you out.

CompareForexBroker comment

The real goal of the stop loss is to prevent you from losing a significant amount of your capital (5% – 10%+) on any one trade. Remember, as spread bets use leverage even a small move in the underlying can translate into large profits or losses.
Yes, stops will often frustrate you, they frustrate all traders and yes, you’ll sometimes place them in the wrong place. But if you use stops when trading spread bets it will mean you have a good understanding of trading and how to approach the game.

So many new traders think spread betting or speculation in general is all about reward whereas it’s about first controlling your risk and risk cannot be controlled without knowing where you’re going to take any potential losses.

So if you use stops it means you’ve addressed the risk problem first, ie how much can I afford to lose on this position. This is how professionals trade and how they can survive year after year. In effect, they worry about potential losses and let the profits take care of themselves.

So work hard at your stops, where to place them and how to build them into your own trading, and ignore this statement at your peril –

“More money has been lost in the markets by people not using stops than all the other reasons put together”

  • See Secret 5 – Always use a Stop Loss – One day they’ll save your (financial) life – which is one of our 10 Secrets to Successful Spread Betting

WARNING! – Spread Bet Broker Advice

There are good spread bet brokers and there are bad ones.
Having a good broker won’t guarantee you profits but a bad broker will probably lead to losses as a combination of their gamesmanship and suspect software takes its financial toll.

About the author:

Justin Grossbard

Justin Grossbard is the co-founder of CompareForexBrokers and since 2014 with the role of Strategic Head Of Research. He is a member of the AICD and holds a Master's and Bachelor's Degree in Commerce. He previously worked with the banking sector, including ANZ and is a contributor to Finance Magnates, Kiplinger and Forbes. He has also published a book on alternative investments which is available on Amazon.

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