Guaranteed Stop Loss
Unfortunately, with a normal stop loss order there is no guarantee that you will be stopped out or filled at the price you specify, because if a market is volatile the price could ‘gap’ straight through. Say you entered a buy trade on a share at 100p, with a stop loss at 94p. Bad news overnight causes the price to open 10p lower than last night’s close at 90p. Your trade is not stopped out at 94p, as the price never trades at this price. Instead, it closes at the first available price below this – 90p – leaving you with a far bigger loss than you planned for.
“On some of the markets your provider might offer you the ability to place controlled risk bets by way of guaranteed orders. By utilising guaranteed orders, spread betting provides you with the potential to realise unlimited profits whilst having the comfort of a guaranteed cap on any potential losses. Guaranteed orders are the only absolute protection against extreme market volatility which, when it occurs, can cause markets to open through or gap through non-guaranteed market order levels.”
One remedy for this is to place a guaranteed stop loss order. Unlike traditional brokers, a number of spread betting providers will offer guaranteed stops on certain markets. A guaranteed stop does what it says, guaranteeing that you will be filled at your designated price… If you are spread betting on a financial security which has a lot of volatility, so you think that a simple stop loss order may finish with your position closed out considerably below your designated stop level, then you have the option of taking out a guaranteed stop loss. This order guarantees that the position will be closed out at your designated price, and not below it, even if the market jumps through it, but you have to pay for the extra peace of mind this type of stop loss brings. This means that you can limit your exposure precisely – no matter what happens to the underlying market. In other words a guaranteed stop loss will close your trade at an exact trigger value you have set irrespective of any underlying market volatility and the gapping that can follow as a result.
So, in a sense a guaranteed stop loss offers a greater level of peace of mind than a standard stop loss. This is, in a sense, an artificial order as the spread betting provider may have to make up the difference in order to close the position at the guaranteed level. In effect, you are buying insurance from the provider, and there is a cost for this. You have to place the guaranteed stop loss order at the same time as you open the bet, and you will be quoted a much wider spread between the buying and selling prices, which you can think of as the premium for the insurance.
“Risk is controlled by using appropriate stops, including guaranteed stops. Guaranteed stops mean that even if for example, a major catastrophe like a massive earthquake were to happen, the worst the spread betting company can close you out at is the figure you have given to them”
Guaranteed Stop Loss Example
For instance, if you went long (bought) the FTSE 100 index at 5100 at £5 per point and were only prepared to risk losing £400 on this trade, you would set up a guaranteed stop loss order at 5020. This means that if some general news happened to push the index past 5020 straight to the 5000 level (market gapping), your spread bet would still be closed out at 5020.
Now you may think that you will use guaranteed stops all the time but I am afraid there are some potential disadvantages.
- Guaranteed stops cost money. Either you will pay a wider spread if you elect to use a guaranteed stop or your account will be debited with a charge. Exactly how much will depend on what you are trading and trading companies differ slightly with their charges.
- Guaranteed stops have to be placed a minimum distance from the current price. This can easily be further away than you would like so you have to weigh up the potential risk to understand whether it is worth using a guaranteed stop.
Also keep in mind that not all spread betting brokers operate the same. IG Index offers guaranteed stops for UK shares, but a minimum distance and a premium applies. For instance you can tie a guaranteed stop on Kalahari minerals with IG Index but this facility is not offered at City Index or Spreadex since they don’t support guaranteed stops on the smaller caps.
The downside is that of course even if the trade goes the right way, and the guaranteed stop loss (GSL) is never needed, you will have paid for that peace of mind in the spread. Because of this some experienced traders think that guaranteed stops are not worth the price you pay for them. So unless you are trading illiquid stocks or very fast-moving markets, or you are just being extremely cautious, you may choose to not use this type of order, as it gives up some profit on every trade. The risk with companies gapping in price is highest when they are about to announce results but it is only occasionally that there is a big price gap between the close and the next day’s open. If you are trading a particularly volatile market or there is a chance of some news that could affect the price, you may prefer to use a guaranteed stop. A sounder risk strategy might be to trade smaller amounts in volatile markets.
However, don’t rely on guaranteed stops if you intend to deal in really big sizes in individual stocks as the spread betting provider is unlikely to want that sort of exposure to big positions in single stocks. Besides which, big boys position trading stocks tend not to use hard stops, but rather just be sensible about managing their positions/risk.
“Guaranteed stops are particularly useful to traders when they are unable to monitor markets themselves and especially when the product they are trading is prone to gapping overnight when the underlying markets are closed. Although there is an additional charge for this service, the guaranteed stop loss order gives you considerable peace of mind when trading in times of volatility on fast-moving markets.”