Spread Betting Orders: Trailing Stops
One of the most important considerations for anyone contemplating spread betting is management of risk, particularly given the degrees of leverage involved in each transaction. Whereas a cash transaction might move at most a percent or two in a day, spread betting transactions are vastly more volatile, simply because of the multiplier effect of the transaction. A widely used (and much sworn-by) strategy for limiting this exposure to risk is to set stop losses - automatic orders to close out a position at a certain degree of loss in order to cap your liability.
But traditional stop losses are not without their flaws, and they do little to protect profitable positions from evaporating, without being reset continually in line with market movements. That's where trailing stops come in, providing traders with the same base functionality of stop losses but with an additional layer of flexibility to meet with the needs of moving positions.
What Are Trailing Stops?
Trailing stops are essentially much like regular stops, but with one crucial difference. Where regular stop losses set a defined, fixed bottom (or top) end to minimise your liability, trailing stops (as the name might imply) introduce more fluidity into the loss level as the market moves in your favour. This has the effect of shifting the stop upwards when it is to your benefit, in order to effectively capture your profits as the market moves more in your favour.
Say, for example, you buy the FTSE at 6000, with a stop set at 20 points beneath. If the market rises to 6100, your stop remains at 5980, until you manually reposition it, which means that you could still lose 120 times your original stake.
Take the same example, but with a trailing stop set at 20 points beneath. If the market is flat, your stop will stick at 5980 as before. However, when the market rises to 6100, your stop will rise alongside it, to 6080, thus ensuring that the maximum you can ever lose is 20 times your stake from the market value. So, if the market then turns around, heading towards the 5980 mark, you'll be safe with your position having been closed in profit, 20 points behind the highest point of the cycle.
Why Use Trailing Stops?
Trailing stops provide an excellent guard against market reversals, and are far more practically useful than their fixed counterparts in terms of their readjustment affect. As the market rises, your profits are effectively banked as you go, without sacrificing any of your position - by keeping a constant check on the degree of market reversal necessary to trigger the close of your position, trailing stops are a highly effective way to limit your risk profile.
Trailing stops aren't the answer to avoiding risk in spread betting, but they can go a long way towards helping curb the possibility of a crippling market reversal. Particularly for positions you don't intend to watch 24/7, the trailing stop can be a helpful way of squeezing the maximum profit from each given trade, while providing a safeguard against losses.
For more information on spread betting brokers offering trailing stops, check out our spread betting broker comparison section.