Perhaps the most well known of all the orders is the guaranteed stop loss. With leveraged trading such as spread betting, the risks and dangers associated with runaway losing positions can be disastrous to your trading account, and one wayward position might even jeopardise otherwise profitable positions elsewhere in your account as brokers seek to offset your losses. The markets can be unpredictable places to do business, and often traders will feel that in spite of their best efforts at logic and reasoning, getting a firm handle on market psychology and the behaviour of markets in relation to price data and extra-market affairs is nigh-on impossible.
This makes the need to mitigate risks at any cost vital to trading longevity, and even in the most apparently stable of positions, the risks of slight market movements (leveraged up to deliver significant losses) should not be underestimated. That’s where the guaranteed stop loss comes in, as a tool designed to allow traders to limit their potential exposure in an otherwise unlimited liability trading style.
Whereas with share trading, traders are limited in their liability to the extent of the original invest – that is, the worst case scenario is that the shares they have bought become worthless – spread betting poses unlimited downside risk, with no cap at any stage on the amount for which your position could be liable. This can and tragically has resulted in traders losing their personal assets, including their homes and businesses, so it’s of paramount importance that you pay serious attention to the management of risk, in which guaranteed stop losses play an absolutely pivotal role.
How Guaranteed Stop Losses Work
Guaranteed stop losses are designed to provide traders with a guaranteed floor price at which their exposure and liability will be capped. An order that must be paid for, and as a result represents an additional trading expense, guaranteed stop losses provide a much needed function for traders looking for peace of mind, and by capping losses at an automatic, defined rate, traders can be better equipped to plan future trading decisions and manage their capital. While the exact positioning of guaranteed stop losses is a balancing act between minimising risk and allowing a position breathing space to naturally fluctuate on its way towards profit, the knack of guaranteed stop losses is one that is quickly gained through experience of using the order.
Guaranteed stop losses work by allowing the trader to establish a set price point at which their position will automatically be closed. This price trigger is set underneath the current market rate, such that if the market happens to fall beyond that price point the trader is insulated from any further degree of risk or liability. This is particularly important, given the impact of leverage in ramping up losses to multiples of the initial stake.
Suppose you held a spread betting position in the FTSE100 market that was sitting at 6000, on a £1 per point stake. Deciding you want to limit your exposure to £10, the guaranteed stop loss would be set at 5990, to ensure that if the market fell to 5989, the trader would already be cut out of the market to prevent any further risk or damage to trading capital. Stop losses are automatically triggered, so traders need not do anything more to close a position or mitigate against the risks of a certain position than execute their guaranteed stop loss order at their chosen price point.
When To Use Guaranteed Stop Losses
Using guaranteed stop losses on a consistent, regular basis is recommended, especially for new traders or for those without the capital to absorb a few heavier losses. Of course, this advice is tempered by the fact that guaranteed stop losses actually cost money, and eat away at the trading profits that can be expected from a particular trade. Nevertheless, many traders would agree that the cost of guaranteed stop losses is a small price to pay for guarding against significant downward turns in trading positions.
With this in mind, guaranteed stop losses should be used as priority in more volatile markets, or in more uncertain trading positions where it seems as though the market might unexpectedly fall away. So, where a trading decision rests on an imminent announcement, such as economic data or a company’s trading results, traders can speculate on the direction of movement they anticipate whilst also taking care to guard against all eventualities.
Guaranteed stop losses can also be introduced after a position has been opened as a sort of banking mechanism. If the same FTSE trade as in the above example saw a rise from 6000 to 6010, the trader may position a stop loss at 6009 to ensure that £9 of profit was safely banked from the trade. From there, if the position moves down, that £9 profit is guaranteed, so the risk to the trader is only the cost of the guaranteed stop loss. This effectively creates a risk free proposition for the trader, because any market reversal will be cut off before it starts to take hold, with any profits realised going forward an added bonus. And furthermore, this process of adjusting the guaranteed stop loss level can be carried on to bank increasing profits as the position moves north.
Part of the beauty and attraction in spread betting is its capacity for unlimited upside gains. If a market rallies heavily in your favour, there’s no reason why a well positioned trade can’t deliver a return hundreds of times in excess of your original stake amount, and many a fortune has been made through shrewd financial spread betting. A corollary of this is that losses are also uncapped and highly unpredictable. While markets can be read and interpreted with some degree of clarity from experience and knowledge of all the relevant factors, that’s never a guarantee of actual performance, and even the brokers are completely in the dark as to whether a position will eventually move up or down.
At the same time, traders have the flexibility to profit from the markets in both directions, which essentially allows brokers to create a mini-market of their own. This means that even in downwards markets, traders can profit from selling a market that is falling away. In this event, the risks are still equally present – should the market rise, the trader will lose. On both sides of the coin, regardless of which camp a trader sits in, a reverse directional movement will accrue liability in the same proportion as always, factoring in the leverage effect.
The guaranteed stop limit performs two key functions in the sense that it helps guard against the losses and cap the profits of positions on the upside, as a ‘limiter’ to what a position can achieve. In many respects it is very similar to the guaranteed stop loss, albeit residing in positive market territory.
How Guaranteed Stop Limits Work
Guaranteed stop limits work in much the same way as guaranteed stop losses, although they are distinct in the sense that they reflect a ceiling price, rather than a floor price, at which a position will be closed. On first reading, this might seem a little counterintuitive – why would you want to cap earnings that are potentially unlimited? The answer is that guaranteed stop limits are a slightly more nuanced issue, and their use is applicable to a number of varied and distinct circumstances.
Firstly, guaranteed stop limits are used as the converse of stop losses in protecting against losses in short positions. When a spread bettor sells a market, a rise in that market is effectively a loss for the trader – even though the market is performing well – because the trader has staked against the market performing badly. So, in the same way in which stop losses guard against runaway liability in buy positions, so too do stop limits guard against risks with sell positions.
Guaranteed stop limits can also be used in the same way as stop losses in banking profits as you go, or can be implemented as a cap in a position’s lifecycle at the point at which traders anticipate a reversal, such that the perceived maximum profit point is defined and the position automatically closed when the market reaches those heights. This can be an effective way to make a satisfactory amount from a trade while also notionally freeing up capital to trade in other markets and on other opportunities. Assuming the stop limit is set at a sufficiently high level, this can be an effective strategy for automating the trade.
When To Use Guaranteed Stop Limits
Like their stop loss counterparts, guaranteed stop limits are a cost centre for traders to take into consideration, and this must be factored in to any equation – whether the stop limit is being used as a safeguard against loss or used to shore up profits. It is advisable to take all possible steps to mitigate your exposure to risk at all times during spread betting, but that’s not to suggest that guaranteed stop limits should be positioned in every single short position you take.
In fact, guaranteed stop limits should be used more readily in markets where the decision to sell is more highly speculative, and where the market could in reality easily turn in either direction. This requires a careful consideration of all the often-complex factors that weigh-in in deciding how a market moves, and an objective analysis of the probabilities of the market moving in a direction that opposes your research and reasoning. If a position relies on some unknown variable and there are suggestions from price data that a market might move outwith its traditional range, its generally a good rule of thumb to make sure you’re guarded with a guaranteed stop limit in place.