Spread Bets carry more risk than ordinary shares. It is therefore essential that investors monitor and manage their positions. Spread betting providers typically make available a number of risk management tools available so as to mitigate the risk of loss. For both long or short positions you may be able to open guaranteed, non-guaranteed or even trailing stop loss limits depending on whether your spread betting providers supports the functionality.
Stop losses: these are automated orders which you can set free of charge. Should the price of the investment you are trading fall/rise to your pre-specifi ed point, your order will trigger and the sale or purchase will be made.
“Ordinary stop loss orders are subject to market gapping or slippage. Only guaranteed stop losses can close a spread bet, and therefore limit your losses, even if the price of the bet ‘gaps’ past the stop loss level you specify.”
Suppose you bought £100 per point (the equivalent of 10,000 shares) of Vodafone at 160p and your stop was set at 150p. If Vodafone were to issue a profit warning overnight and the stock opens at 140p the following morning your stop loss order would be executed at 140p – not at 150p as requested, because of the slippage in price. Gapping like this can happen during regular market hours too and across all different markets.
How does a Guaranteed Stop Loss work?
Both normal stop loss orders and guaranteed stop loss orders are risk management tools. GSLs allow spread traders to lock in a guaranteed exit price for their shares.
“As the name suggests, a guaranteed stop loss order is a type of order that guarantees a price level where you will be automatically stopped out of a spread trade should the market turns against you. The guaranteed level or price where you will be stopped out will be pre-arranged with your spread betting provider. This is usually a few pence or a certain percentage away from the market price of the spreadbet you want to trade. Guaranteed stops attract a certain premium and is normally paid the moment you place it, not when it is executed. Not all spread betting providers offer guaranteed stop loss orders, so you
have to check with your provider.”
Large orders that are normally executed without problems in normal market conditions may be subject to market gaps when trading volumes dry up or when there are sudden market movements. For instance, world events such as the earthquake and tsunami in Japan can trigger a high level of selling, resulting in markets opening sharply lower than their previous close.
Some spread betting providers cater for this by permitting spread traders the ability to set a guaranteed stop loss order on their trade so that if the market goes against them, they would have no further exposure beyond that particular level. A guaranteed stop loss order in practice means that you will sell the stocks at a given price regardless of underlying price movement (e.g. a guaranteed stop loss of £1 will sell shares at £1 regardless of whether they fall to £1 or 40p.
A “normal” stop loss will dump the shares at whatever price you can get once the stop loss has been breached. Taking the example of RPT recently, a “guaranteed” stop loss at 80p would sell your shares at 80p, whereas a “normal” stop loss at the same price would have struggled to sell shares above 40p.
“A guaranteed stop loss will always get you out at the specified price level, but these can only be put in place when you first open your trade. GSLs work in a similar manner to stop losses. The difference is that you are guaranteed to sell/buy at the exact price you set. This protects you from market ‘gaps’ (if your stock (GSL) never trades at the price you set). You could consider the guaranteed stop loss to be equivalent to buying a put option at a given price with an (indefinite?) expiry date, which is automatically exercised when “in the money””
With ‘guaranteed stops’ your spread betting provider guarantees to close your spread trades at the price indicated in your guaranteed stop loss order. Moreover, before you can open a spread trade you must have enough funds in your account to cover the maximum possible loss. In this way you cannot lose any more funds than the monies you deposit. Guaranteed stop loss orders do not require a complex trading strategy, spread traders simply have the option to add a GSL at the time they place their order. Typically the guaranteed stop loss price spread betters choose will mirror the level at which they would like to exit the trade in the event of a stock price fall, while still allowing some room for normal day-to-day market volatility.
A Guaranteed Stop Loss Example
For example, let’s suppose you have bought a long Rio Tinto spread bet at 3750p and have put 3500p as your maximum loss level. You can utilise a Guaranteed Stop Loss Order to ‘guarantee’ that should Rio Tinto reach 3500p, the spread betting provider will automatically close out your spreadbet at this level, to prevent you from sustaining any additional losses.
Unfortunately some bad copper production data push Rio Tinto’s stock price lower to 3450p, and the spread betting provider automatically closes your position out at 3500p. So even though Rio Tinto’s stock price traded past your maximum risk allowance, the Guaranteed Stop Loss stopped your losses by automatically closing out your trade at the pre-determined agreed level.
Taking our original Vodafone example above where you had bought £100 per point of Vodafone (the equivalent of 10,000 shares) at 160p and your normal stop was set at 150p and where you where your exit was executed at 140p due to market gapping.
If you had paid to turn your stop order into a guaranteed stop order one, you would have been filled at the specified level of 150p. At Capital Spreads the cost of guaranteeing your automatic stop loss for FTSE shares is 0.50%, so in this instance a cost of £80 ([160.0 x £100] x 0.50%). This might look expensive but in the example above, you would have ‘saved’ an additional £1000 loss caused by being slipped to 140.p
Most traders tend to utilise guaranteed orders in instances where they are trading volatile instruments or when trading an individual stock that may be susceptible to corporate action. As the Vodafone share example illustrates, stocks can be prone to big moves when they open – either higher if, for instance, they are subject to a takeover bid or lower if they release a profit warning.
What Providers don’t Tell You: To guarantee or not to guarantee, that is the question
There are some specifics you need to know about when evaluating whether or not to guarantee your stop loss order, such as the minimum distance they have to be left away from the present market price. Also, there are maximum limits to the stake size that providers will accept for a guaranteed stop order.
Some providers also allow traders to move the guaranteed stop loss order level with their stock price without charging any extra fees. For instance, keeping the same stop distance from market and expiry date as their original guaranteed stop loss orders, traders can change the limit to track with their stock price. This allows them to lock in gains while still retaining protection against volatility.
For dealings in markets where gapping is uncommon or for trades that you expect to last only a few mintues, there is normally no need to use guaranteed stops. It is also worth noting that index and forex markets are very much less prone to slippage. However, this doesn’t mean that this doesn’t happen particularily if something unexpected happens or an important piece of economic data, such as the non-farm payroll numbers, surprise significantly to the downside or upside.
Note: In my experience, guaranteed stop losses are usually only offered on liquid FTSE 100 stocks (and perhaps a number of FTSE 250 and other liquid index markets..etc) rather than small, volatile shares listed on AIM or Small Caps (as the risk is far larger for the latter). You can long or short with guaranteed stops but you have to be in early or the stops can be quite wide. I remember shorting AVN against a launch failure with a 12.5% stop and when I went back for more they wanted 25%! That’s acceptable but obviously requires a much smaller position. If a stock is being heavily shorted/longed it can go to telephone trading only…so it’s not ‘easy’ but it is a way to enjoy some of the higher risk stuff.
What do Providers charge for Guaranteed Stop Losses?
In addition, a guaranteed stop loss comes at a additional cost over and above a ‘normal’ stop loss. So for the extra premium you’re getting extra protection, just like an insurance policy. Guaranteed stop loss charges are dependent on the contract you’ve chosen to trade. The charge for Guaranteed stop losses can be found on the Market Information Sheets.
In fact I’d say trading with guaranteed stops is a great idea until you discover the extent of this additional cost. For example with IG the commission is 0.1% on CFDs for a non guaranteed stop but 0.3 % with a guaranteed one. Correspondingly with a spread bet you’ll pay a much wider spread and believe me it makes a big difference to the maths. Having said that guaranteed stops are a good choice in certain scenarios though especially for holdings that could potentially be wiped out by one RNS – and if it helps you sleep at night so be it.
Note: Guaranteed stop loss orders can also be dangerous if you aren’t careful with them. IG [for example] stop out on their internal prices – not the market price. So if their internal prices were to spike you will get stopped out. Some providers also impose limitations on guaranteed stops. For instance with IG Index at the time of writing I can only place bets of £20 in Mouchel stock with a GSL and anymore must be placed in increments of say 5 points.