The CleanFinancial.com guide to Stop Loss orders.
- Why Use a Stop Loss?
- How to Tighten a Stop Loss
- How to Widen a Stop Loss
- The Downside?
- What Else Can Go Wrong? Gaps
- Where Can I Get a Stop Loss?
Many people highlight the main risk of spread betting as being the possibility of losing thousands of pounds on volatile markets. And they are right.
With financial spread betting you often risk winning or losing a sizeable sum on each bet.
So how can you have all the upside and limit the downside?
Have a look at adding a Stop Loss order to your spread bets. If your positions are going pear-shaped and you start losing a lot of cash, a Stop Loss can close your trade and stop you from losing any more money.
However they do not limit your upside if your trade is going well.
Why Use a Stop Loss?Let’s wind the clock back for a more extreme example of when the markets were spiralling down because of the credit crunch.
Many spread bettors were selling the FTSE 100 and Dow Jones as the markets accelerated downhill. The US Federal Reserve then, unexpectedly, cut interest rates by 0.5% and the markets rallied sharply.
City Index and CMC Markets reported that a number of clients hadn’t used Stop Loss orders and so got their fingers burnt. A classic example of why spread betting has a bad reputation.
Meanwhile Simon Denham of Financial Spreads – where a Stop Loss is automatically added to all new opening trades – said that “a few individuals lost a few thousand here and a few thousand there…however we didn’t have to make the big margin calls like other firms”.
In short, Financial Spreads protected their clients who were selling the FTSE 100 and the Dow. Their clients still lost money but not as much as they would have without a Stop Loss.
How to Tighten a Stop LossWith a firm like Financial Spreads and Capital Spreads, you can generally tighten your Stop Loss when placing the order.
If you only have a few hundred pounds available to trade then the level your Stop is set at is often proportional to the amount of money in your account.
To tighten the level of the Stop order simply update the Stop Loss field on your trading ticket.
You can often tighten the level to within a few points of the underlying market, although this is not necessarily advisable as any quick market movements could easily hit your Stop order and close your trade, albeit for a small loss.
Also see our Guide to Reducing Your Risk When Spread Betting.
How to Widen a Stop LossAs mentioned above, if a Stop Loss is automatically applied to your trade then the level of the Stop is often proportional to the amount of money in your account.
If you want to widen your Stop Loss you might need to deposit more funds. If you can afford it, you can put more funds in your account and then update the Stop Loss level from your order ticket.
If you can’t put more funds in, you can’t afford the risk. By depositing more funds it also reminds you of how risky the markets can be.
You can normally also adjust the level of your Stop, provided you have the funds in your account, after you have opened your trade.
The Downside?One negative is that in highly volatile markets you can find that your trade swings too far one way, the Stop Loss kicks in and closes your bet… and then the markets move back the way you wanted them too. This is a very common complaint in most trading forums.
Without a Stop Loss your trade would be fine but with a Stop Loss you lose (because your position was closed before the market recovered).
Of course, as mentioned above, if you’re in a volatile market and are worried about this happening then you can always set the Stop Loss to be further away, i.e. widen your Stop.
As a side note – if you think your spread betting firm is trying to pull a fast one then just check the price moments against some independent charts e.g. those on Bloomberg. You’ll generally find that the underlying market did trade at the level of your Stop.
What Else Can Go Wrong? GapsStop Losses are not guaranteed.
The markets can “slip” or “gap“. The markets rarely move smoothly and therefore your Stop Loss might be closed at a different level to the level your Stop was actually set at.
This is because the markets slip, gap or jump across the level of your Stop Order. When that happens the order will kick in at the next price that’s traded.
Let’s say you buy the FTSE 100 at 6698 and your Stop Loss is set at 6658.
- If the FTSE dropped to 6670, your trade would still be open, you’ve not hit 6658 yet
- If the FTSE then dropped to 6660, your trade would still be open as you’ve still not hit 6658
- If the FTSE then dropped to 6652 (i.e. it gapped over 6658) your trade would be closed at this level of 6652 not 6658. This is because the firm never offered 6658, the market moved from 6660 straight to 6652
For a small premium though you can protect yourself from market gaps by choosing a Guaranteed Stop Loss rather than a Stop Loss. For more details, please read our guide to Guaranteed Stop Loss orders.
Where Can I Get a Stop Loss?
|Stop Loss Available|
|Automatic Stop Loss|
Spread betting and CFD trading carry a high level of risk to your capital and you may lose more than your initial investment. Spread betting and CFD trading may not be suitable for all investors. Only speculate with money that you can afford to lose. Please ensure you fully understand the risks involved and seek independent financial advice where necessary.