Spread Trading and Stop Losses

Spread trading and stop loss orders… We all want to be successful in trading financial markets, but it is unlikely you’ll make the right decision on every trade you make. That’s why it’s so important to have a solid understanding of the rules for risk management in particular stop loss orders and limit orders.

Everyone has different trading styles, strategies and pots, but me personally the stop has to be the primary focus and that’s to help telling how much I’m putting at risk before i enter the trade.

Taking my Dow trade of yesterday for instance my entry was at 12665 target was 12710 and my stop was 12638, which is a fairly small stop for a Dow trade but my reasoning was the 15.30pm candle which had a low of 12642 would act as support, I think that with stops people just have a fixed number be it 15, 20, 25pts or 10, 20% on stocks. I just feel it’s a tad more beneficial to be that little bit more strategic in picking your stops, turnaround candles, fibs, moving average, all give you that extra bit of protection, which in my book is worth the extra few points risk, the amount of times this keeps me in a trade it cannot be luck as my nephew calls it.

The ability to take a loss is probably one of the most important factors in trading, it’s horrible and it makes you feel sick, but most traders have had that trade oh i’ll give it another 5% oh news is due will wait till then hmm now it ain’t worth selling and before you know it your looking at a 100% loss, discipline is the key lose a battle to win the war, I think most agree there is bad news in the pipeline, but we must remember all these downgrades the market has dismissed them so far, as the quote goes the market can remain irrational longer than we can remain solvent!

Spread trading companies typically offer a number of order types to help traders manage their trades more efficiently. Spread traders can utilise stop orders to automatically close a trades so as to help curb losses from escalating past your maximum loss levels, without needing to be in front of your trading screen. You can place stop loss orders to automatically close your trades at pre-defined price levels, therefore, drastically reducing the risk to your capital. In some volatile markets it is suggested to make use of guaranteed stop orders which will ensure that your trades are closed out without slippage or gapping issues i.e. no further money is lost should the price open at a different level to the closing price of the earlier session. Meanwhile limit orders can also be utilised to automate the profit-taking on a trade once it reached a preset level of profitability.

Standard stop loss: A standard stop loss is offer by all spread betting providers (free of charge) and is available on all markets. Once triggered, a normal stop loss will close out your trade at best execution. In the event of market prices gapping (i.e. slippage), where prices ‘jump’ from one
price to the next without ever trading at the levels in between, this could mean that your trade is closed out at a price worse to that of your requested stop loss level.

Guaranteed stop loss: This guarantees to close out your spread trade at a pre-determined level irrespective of market gapping. For this reason guaranteed stop losses offer better protection that normal stops but guaranteed stops come at a premium for the added protection.

Stop losses can help minimise the potential downside but without guaranteed stops you are vulnerable to slippage in fast-moving markets. This means you could end up being stopped at a worse level than your specified stop. Guaranteed stops help to insure against this but normally spread trading providers will charge you extra and only permit you to place stops a minimum of 10% away from the market price.

Whatever you do, understand the market you are trading. This also means familiarising yourself with the different types of stops and knowing how to use the. A stop loss order is a mechanism that permit you to exit a trade when the price you have named is hit. Meanwhile, limit orders and trailing orders are also available which are useful to automatically close your spread trade at a predetermined level to maximise your profits.

But let’s get back to discussing stops. If you bet on a rising stock using a financial spread bet, your obvious risk is that it goes the other direction and falls in price. A stop loss order cuts your risk and is an instruction to your spread betting provider to cut your losses if the market hits a specified price. One type of stop is the guaranteed stop; these cost a little bit extra in terms of a wider spread however it is probably worth paying the extra premium if you are new to trading. Once you acquire some experience then maybe it is not worth continuing to pay the guaranteed cost premium.

However, beware not to place a stop too close on a highly volatile market. Forex pairs, for instance, tend to move quite a lot on a daily basis, while blue chip stocks tend to be more stable. A trailing stop is also available with some spread betting companies. A trailing stop moves your stop up with the market. You can still do this manually with a normal stop loss but it can be a pain continually editing an open trade.

I also have a habit of getting up early and adjusting all my stops prior to market open… it’s like a litany.. Spreads were a bit wide this morning but I was kinda expecting it after Friday. I just loosen my stops first thing and then tighten then again when I get back from the school run.. of course if it turns into a down day while I’m out then I can end up getting stopped out for more than I would like, but that happens very rarely so overall it works for me as a strategy (famous last words).

Rant: My rule for stops at -10% are largely being tested at the moment, HVN just one. I am wondering whether it is ever worth changing ones “rules” to fit in with news driven events. I find myself going through plenty of justification for waiving my rule but feel it must be bad management and I should ignore the emotion of the situation. Comments?

Reply: I use staggered stops (only feasible on spreadbets). Place a series of (say 3) smaller bets per stock rather than one large bet. Set differing stops on each tranche. One to exit at say -5%, one at say -10%, and third lot at say 15% (or whatever mix). That helps takes the emotion out of ditching a position; knowing that you’ve generously given it three chances to behave. And ideally make them trailing stops of course.

Rant: When stops really don’t work. The lovely Market Makers shook PHTM today from 62.5 to 50p then put the shares in auction and when they came back quickly went up to 58p. I had a stop on at 57p ( placed when the share price was 68p) but the fall was so quick i got taken out at 50p. I guess this was a shake so some big fund managers could get in nice and cheap. This just feels like highway robbery to me. I got back in at 54p but had I not had a stop loss on i would be little worse off now instead of losing a sizeable chunk of my profit today. If I hadn’t been free to get back in I would have lost pretty much all my profit. Not convinced at all about these stops..they have done nothing but lose me money so far in my trading…..yes I know what you are going to say 😉

Reply: Getting stopped is part of the game. Its regrettable that you have been stopped at a loss because by sheer luck you came to the game at the wrong time. Had you started trading about a year ago in the same stock you would feel on top of the world because PHTM went from 40p to 80p in two months, so even a 20% stop would still have given you a very good profit. What UKI says is true, mental stops work best but only if you can regularly check prices say two or three times a day. We’ve all shared your experience but most times you won’t get stopped on a spike. If the experience was too emotional perhaps a lower risk money management would be appropriate but trading without stops is financial suicide.
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Rant: I’m not too emotional about this but I was using mental stops until recently when I was told by some here that I should use actual stops. I had lost money early on by these kind of spikes when I was using actual stops and that’s why I ditched them. I think my entry point here was pretty good and there was plenty of room for pullbacks. I’m still in profit here but i’m confused with tactics. I think I will go back to not using stops again. No blame attached to anyone here BTW. It just seems to me that when you are first building up profit in a share it’s just too easy for the MMs to get you out. I had 45% profit in this at one point and it seems to me that this kind of manipulation of small investors by these guys is pretty dishonest. I’m in this for the next 10 years at least but I’m thinking that maybe now is the time to hold some cash and wait for the market to bottom out if that’s what it’s going to do.

Here’s a thought re the stops and PHTM. For stocks that I hold where I have opted for a buy and hold strategy, I don’t use a trailing stop. I set my stop initially and then see how it pans out. I up my stop level to break even but only when the stock has gone up a lot. My thinking is this – if the stock was good enough for me to enter a trade in the first place on a 3:1 risk/reward target, and that reason doesn’t change, then I am happy to run the trade. If I am tempted to use a trailing stop then either there is a tangible reason in which case I tend to find I am better off taking profits, or I am getting twitchy and acting out of a fear/greed impulse and I go and put the kettle on. All of this so much easier when I am within my 1% framework. Over the last few days I find I have been stopped out of a couple of trades which is sort of ok – I am planning to buy back cheaper – and kept hold of other stocks which have rattled around a bit but basically they are long term holds for me (eg MML, DIA).

Rant: I had been doing very well up until late turning my 80% loss into 20% gain after recovering my loss slowly with small trades. This week is a different story though, it’s almost like the LSE has been targeting my stops as I’ve had several stop out losses only to see a recovery. I had this a while back and deduced I was being a little tight with my stops and rectified it. Maybe subconsciously my stops have crept up again and I need to step back and review them again. I do think it is important to regularly review your trading patterns.

Comment by Brent: Stop losses are too easy to manipulate and only sell when your asset goes down. That is the opposite of buying low and selling high. As such the theory of risk management fails because there is no guarantee as to how low your sale price will actually be, you just know the amount you could possibly lose. There are some psychological benefits particularly if you can’t continually monitor the markets.

Note: You should definitely consider big stops, all too often you’ll get stopped out on a small stop when the real price gets nowhere near it. I’m not sure the spread betting companies play fair. As for setting stops: I used to do a lot on CFDs and it was far from unusual to get momentary spikes of -10% or more on some of the heavily traded stocks. Sometimes you literally could not see what happened until you back-tracked through the trade record. I once had a -20% drop that lasted less than 5 seconds – nothing I could do about it! Then the price was back up to where it had started. I would suggest you to complain if something looks wrong after being stopped out.