Opening spread betting trades is only one part of your trading. In particular you also need to manage trading positions to make sure that they are doing what you expect them to do. And if they are not doing what you expect them to do, then you must be able to get out of trades quickly.
One of the advantages of trading spreadbets is the availability of risk management tools and order combinations that will help you manage your trades. Most spread betting trading platforms support a range of automated orders that enable clients to leave an instruction to deal should a certain specified price be met, with the main orders being stops and limits. A ‘stop‐loss order’ is a tool used in spread trading to limit the losses on an individual trade. It quite literally means when the loss on a trade reaches the point where I no longer want to risk any more money then ‘get me out’ (close or ‘stop’ me out) of my trade.
A stop loss is an order placed with your spread trading company to buy or sell once the share, index or commodity reaches a certain price. A stop-loss point or level is a pre-determined price at which you want to get out of a spread trade if it goes against you. It is designed to limit your loss on a trade. Placing a stop‐loss order for, say, 20 points below the Entry price will limit your loss to those 20 points.
Let’s say you thought Barclays will go up so you entered the trade, going LONG, at 145 at £50 per point. Right after entering the trade you enter a stop‐loss order for 125 (20 points below). This means that if the share falls below 125 your trade position will be closed, limiting further risk to your funds. You have entered the trade knowing what your maximum risk/loss might be if the trade goes against you. 145 – 125 = 20 points against you at £50 per point = £1,000 loss.
This is important…
If you didn’t place a stop loss order and the share dropped down to 100 when you closed the trade you would then be facing a loss of 145 – 100 = 45points against you x £50 per point = ‐£2250. Absolute worst case scenario ‐ if the share fell to Zero you would be looking at 145 x £50 = ‐£7,250.
I am sure you can now see the importance of using a stop loss.
Most spread trading companies now insist on a stop‐loss order with every trade to protect both you and them. They will often put an automatic stop loss level on any new trade however you can change or amend the level of the stop loss.
Every market has a minimum distance from the current price at which any stop will be accepted. You may move the stop further from the current market price provided your account has sufficient funds to do so – the system will not permit you to move your stop level beyond such available margin.
Again some spread trading companies such as Capital Spreads automatically cancel the stop loss order when a position/trade is closed. Other companies treat them as separate orders and require you to instruct the stop loss to be cancelled. It is important to make sure you are familiar with your company’s practice on this.
Where to Place the Stop
There are many rules of thumb when it comes to setting your stop and how much you should risk. “Do I put my stop just below the low, no maybe above it”, “should I risk 5% of my cash balance or three quarters of it”, “is the best risk to reward ratio 2 to 1 or 5 to 1”. In honesty there is no right or wrong answer to any of these as different “experts” will tell you different things. The most important thing is to set your risk according to your strategy and ultimately how comfortable you are with it.
Prior to opening a position you should have already planned the exact point at which you want to get out if the trade turns against you. When you enter a trade only
three things can occur:
- your analysis was correct and the trade moves into profit.
- your analysis was wrong and the trade moves into a loss.
- you pick an outstanding winner and the trade trends strongly in your favour.
Clearly the 3rd option is the best result but you never know when the big wins are going to come your way so you need to remain vigilant and always look to avoid the large losses.
Stops are essential to skew the trading edge in your favour. If you eliminate large losses and use good analysis to determine when to enter trades then you’re likely to be successful. Remember no analysis will be correct every time and stops take care of what happens when the trade does not work out as planned. ‘Cut your losses off short and let your profits run’ is repeated over and over again in the markets and is an essential part of a sound trading strategy for any professional trader.
Once you have established whether you want to buy or sell, you should immediately establish at what level you will exit the position if it goes wrong. Our system has stop loss orders automatically attached* to every open trade and you can decide whether you want it set closer or further away.
There are a few methods you can use in order to set the level of your stop order and below are a couple of the main ones professionals use to keep them safe and protect their risk in the market.
Percentage Based Stops
By far the easiest stop loss method to choose from as you simply set your stop a set percentage from where you got in. If you happened to enter a trade at £10 and wanted to place a stop 7% away, then you would place your stop at £9.30. Traditionally this has been a simple strategy used by longer term investors instead of active traders as this particular stop loss doesn’t take into account the volatility of the share prices. It can also be somewhat challenging as high priced stocks have stops that are some distance away and low priced stocks tend to have stops that are very close, so do consider these points if you decide to run with this stop loss method.
Technically based Stops
Technically based stops are placed depending on the current price action and at a place where the market has signalled a change in direction or volatility. A stop placed below a trend line, below a support level or below the last turning point could be used to get you out of a long trade. A stop placed above resistance, above a down trend line or above the last turning point could get you out of a short trade. All of these stops are based on a particular pattern that can be detected in a chart and can be defined as subjective stop loss strategies as it’s possible for 2 traders to identify different exit points depending on their rules for trends or support and resistance lines.
There are a number of possibilities when it comes to placing stops into the market and professional traders never rely on just one but can in fact have several running on the one trade. Over time you’ll develop a good feel for what type of stop works best for different trading instruments and you’ll be able to tailor your trading plan accordingly.
Another often overlooked aspect is the power of creating a series of dedicated rules when it comes time to exit the market at a loss or in profit. During the heat of the moment, it is much harder to keep a steady head and not let your emotions take over. That’s why having stops set in place the moment you place your trade is so vital. This one tip alone could potentially save you hundreds or thousands of pounds and a lot of heartache.
The Positives and Negatives of Stop Losses
Most spread betting providers offer stop-loss orders as a regular feature of their trading platform at no extra cost. The obvious advantage of a Stop Loss order is that if your trade/position is going against you it will cancel the trade once it reaches the stop loss level thereby protecting your interests by limiting your risk.
The disadvantage is that the stop level could be executed by a short‐term fluctuation or ‘blip’ in a share’s price. The key is picking a stop‐loss percentage that allows the share to fluctuate within its normal trading range while preventing as much downside risk as possible. Setting a 5% stop loss on a share that typically ranges more than 10% in a day is not the best strategy: you’ll most likely just lose money on the execution of your stop‐loss orders.
There are no hard and fast rules for the level at which Stop Loss orders should be placed. This totally depends on your individual investing style and the results of your research.
Another point to bear in mind is that once your stop price is reached, your stop order becomes a ‘market order’ and the price at which you close may be different from the stop loss price. So even if you have nominated a stop-loss or exit level, there is a possibility that your position would not be closed out at exactly at that price if there is insufficient against your order size in the underlying market. This is especially true in a fast‐moving market where share prices can change rapidly.
Whatever you do avoid setting your stop too tight to the entry price as this leave little room for everyday market fluctuations. In such instances it is better to reduce your position size while widening the stop to give your trade a better chance of turning a profit.
Note: Make sure that your spread betting provider allows you to adjust the levels of your stop loss orders – this can usually be done online for free.
Other uses for Stop Losses
Another important use of the stop loss tool is to lock in profits. This is sometimes referred to as a ‘trailing stop’. Here, the stop‐loss order is set at a percentage or set number of points away from the current price offered by your spread trading Company. The stop loss moves in line with price of the share. Remember, if a share goes in your direction, what you have is an unrealized gain, this means you don’t have the cash ‘in hand’ until you actually close the trade. Using a trailing stop allows you to let profits run while at the same time guaranteeing at least some realized gain.
So continuing with our Barclays example from above, say you set an initial stop loss order for 20 points below the entry price of 145, and the share goes up to 170. You could then fix your stop loss to trail, say, 10 below the share price so in this case your stop loss would move to 160 (170 – 10 points). This is the worst price you would receive, so even if the share takes an unexpected dip, you won’t be in the red but 15 points in profit (160 – 145 = 15 points at £50 per point = £750 profit). Again, keep in mind the stop‐loss order is still a market order – it’s simply stays dormant and is activated only when the trigger price is reached ‐‐ so the price at the close of your trade may be slightly different than the specified trigger price.
Stop‐loss orders can help you stay on track without clouding your judgment with emotion.
It’s important to realize that stop‐loss orders do not guarantee you’ll make money spread trading; you still have to make intelligent informed decisions however they are a very important part of good money management and controlling your losses.
You should never trade without a stop loss.
A stop‐loss order is such a simple little tool that its importance can be overlooked. Whether to limit your losses or to lock in profits; nearly all trading styles can benefit from this tool. Think of a stop loss as an insurance policy: hopefully you will never have to use it, but it’s good to know the protection is there should you need it.
The advantage of a stop loss order is that if your trade/position is going against you it will cancel the trade once it reaches the Stop Loss level thereby protecting your interests by limiting your risk.