Guaranteed Stop Losses or Ordinary?

Q. What is a guaranteed stop loss order or controlled risk bet?


A: Normal stop loss orders are free but they do not guarantee that you will be stopped out at the exact 'stop loss level' and may be subject to slippage or market gaps. Guaranteed stop loss orders (or controlled risk bets as they are sometimes referred to) on the other hand are guaranteed to 'stop' your trade at a pre-determined price level irrespective of whether the market actually trades at that price.

Let's suppose you place a trade on Bt Group (BT.A) at 118p with a 105p stop loss order. If Bt Group stock were to close that day at 115p but the company then issues a profit warning the next morning and the shares open at 80p, your trade will be closed about 25p below your stop loss level. A normal stop loss won't trigger outside of market hours, so in the case of Bt Group the stop loss would only activate when the market opens. In contrast, with a guaranteed stop loss, your spread betting firm would stop the trade at 105p as per your instruction and thus capping your losses in the process. So in effect here with a guaranteed stop loss you are buying insurance and peace of mind.

Some new traders might love the extra security which controlled risk bets bring to the table; which effectively means that such stops remove the unlimited risk liability of spread betting. The catch is that guaranteed stop loss orders carry an additional premium in the form of a slightly wider bid-offer spread. The cost of this insurance varies by market and provider; for instance City Index will charge 1% for the value of a share spread bet. Thus a £10 per point spreadbet on Bt Group (equivalent to 1000 shares) entered at 118p would cost you £11.8 (£10 x 118p) equivalent to 1% of the market exposure. Of course, there are situtions where such stops are desirable; for instance in situations where you expect announcements that are potentially big market-movers.

In practice, guaranteed stop loss orders only cover you for out-of-hours movements above a conventional stop. Thus, you are paying a premium to insure against an event which you can control by not trading crappy small stocks. Trade the liquid big caps and you come very close to removing the overnight risk.

Not all providers offer controlled risk stops. For instance, Capital Spreads in the past didn't offer this facility - although it now does offer guaranteed stops. IG Index on the other hand offers the option of a 'Limited Risk Account' where all of your trades all tied to a guaranteed stop loss level and you must have sufficient funds in your account to cover the possible shortfall (thus assuring you that you will never lose more than what's available in your account).

As the market plunged some 1000 points on 6th May 2010 the Dow Jones crashed 9% in a matter of minutes - stop losses were triggered, cancelling many open trades. 'Fine', you might think. But that left many long traders in tatters. But of course that was one freaky trading day and stop loss orders are still a vital tool when it comes to avoiding losses that could cost you your shirt! - MoneyWeek

Q. What's best using a guaranteed stop loss or ordinary?

Still getting to grips with spreadbetting, pretty annoyed at being bounced out of a Tate & Lyle long last week, my first £10 a point spread for £190 and today I would have been up £150. I used a guaranteed stop loss and I am right in saying that you can't alter it. I'm a little bit nervous of using an ordinary stop loss, how quickly do they get you out? What's best using a guaranteed stop loss or ordinary?

A: Simple stop loss orders are free to place with your spread betting provider. When a stop is hit, the broker will do their best to execute your order at the stop price. But usually you will get a price a tick or two from your stop loss, depending on how a liquid market you are in. This is called slippage. It's no big deal and should be factored into your trading plan anyway.

I don't often make use of guaranteed stop losses - though I fully understand the sense in doing so. Sure, guaranteed stop loss orders bring peace of mind but this comes at a cost as your spread betting company will charge you a wider spread for the privilege and it is often not possible to place them where you want to. Just checking 'Next' stock (NXT.L) for instance, I see that one spread betting company was quoting a spread of 1,812p - 1,820p (spread of 8 points) but for a guaranteed stop loss this same spread widened to some 16 points. The general opinion amongst experienced spread betters seems to be that guaranteed stop loss orders are useful in certain situations but over time, the cost of these positions will probably tend to offset any savings you make from market gaps. Most of the times you will be better off focusing on stake sizings as a way of restricting losses in risky sectors, rather than paying the extra premium for guaranteed stops.

In any case the best thing is to chat with someone at the firm about what can and can't be done regarding adjustment of stops, and how close or far away they can be set, as rules differ between the various firms. Usually best to phone them outside market hours when call pressure is less hectic and they'll take time to chat. There is nothing to stop you having the same chat with the spread betting firms that you are not using, as some are better at explaining things. Just pretend you are considering opening accounts with each.

£10pp on a stock of that price sounds quite big for someone finding their feet, if you don't mind me saying so. Equates to a shareholding of around £6900.

Stake(£) x shareprice(p) = shareholding value(£)

One point - which you may know already; the stops can be set so they are triggered by the market price, or by the firms own quoted price. The latter will sometimes be a long way from where the market price currently is and might swing around more than the market price. Some firms ask whether you want the stop determined by market price or quote price. If you opt for market price, the stop will be triggered by movement in the market price, but will nevertheless be executed at whatever is their current quote price - so you need to keep an eye on both to fully understand what's going on.

P.S.: With spreadbetting there are several oddities that only become apparent when they happen. So it is worth getting a wide sample of bets of different kinds under your belt over several months before thinking it's safe to ramp up your stake sizes. I have been spread betting several years now, and I still sometimes get caught by technicalities (e.g. miscalculating the adjustment involved when certain corporate actions kick in).

Q. How much do Guaranteed Stop Loss orders cost?

A: Most CFD and spread betting providers offer guaranteed stop loss orders. If you intend to use guaranteed stop loss orders in your trading be wary that the charges can vary substantially across brokers and you really need to shop around to find the best value as guaranteed stop loss orders can easily double transaction costs.

For instance City Index charges 0.15% for trading UK shares and an additional fee of 0.25% for taking a guaranteed stop loss order. Of course this 0.25% guaranteed stop loss fee is just a start - the premium charge can go up by as much as 1% for trading particularly volatile shares. For example in the case of IG Index guaranteed stop loss premium starts at 0.30%.

When working out your maximum amount to risk - the minimum stop loss distance also plays a key role. IG Index requires a minimum stop distance of about 5% to 12.5% depending on the share (in general the more volatile/the smaller the share the bigger stop loss distance required by your broker). In contrast City Index stipulates an all-inclusive policy of 10% for all UK shares.

For the FTSE, IG Index stipulates a minimum stop loss distance of 10 points on the FTSE 100 rolling while CityIndex will not allow stops nearer than 40 points. Brokers also have different charging structures for spread bets on indices - for instance IG Index adds 2 points to the spread on a FTSE 100 daily while City Index the charge on a FTSE rolling trade is 2 X the quantity that you are trading.

So for instance: If you place a £10 a point trade with a guaranteed stop loss at City Index the charge is 10 x 2 = £20. This charge would show on your account statement. IG Index, on the other hand will add 2 points on the FTSE 100 daily so in effect any gains you make would be £20 less or any losses £20 bigger.

Most providers will also allow guaranteed stops of forex trades. The charge for these at City Index is 5 x stake. So if you do a £3 trade the charge is £15.

Update: Ayondo now offers free guaranteed stops on most of their markets except individual shares. This means that you can take advantage of free guaranteed stops on every trade without slippage (subject to a minimum stop distance and maximum stake).

Q. How can I cover the risk of a takeover when shorting without using a Guaranteed Stop Loss Order?

A: To cover the possibility of a takeover you can place a counter bet in the opposite direction to open at a certain price, say 15% or whatever over your short entry price. This tactic can also be used if the 'margin' requirement for a share is higher than the amount you would like to be exposed if the trade goes against you. In these circumstances you may lose some money due to gapping...however you will be covered against a catatrophic event.

 ...Continues here - How much do Guaranteed Stop Loss orders Cost?

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