Introductions to Stop Loss Orders and Leverage

Q. What is a Stop Loss Order?


A: Nobody, but nobody has a 100 percent success rate which is why you need the discipline to cut losses early. A Stop Loss Order is a safety net which limits your losses should the market move against you. When placing a spread bet you are taking a risk that you won't correctly predict the market direction - for instance if you go LONG the market can still go UP or DOWN and if the market goes down this will translate in a loss on your spread bet position. Now, trying to rely on hope is futile - you need to ensure that you have an emergency exit should things not go to plan and this exit is the Stop Loss Order. Learning to accept many small losses allows you to protect your capital for the winning positions, but this is only possible if you have a trading plan.

There are two types of stop orders - normal stop orders which are offered by the providers free of charge and guaranteed stop loss orders (aka as controlled risk bets) where you are charged a little bit extra in the form of a wider bid-offer spread but the stop loss level is guaranteed. Although the spread betting company will try to close your bet at your stop order on a best execution basis, in some cases you may still be closed out at a price higher or lower than your stop. This is because in fast moving markets shares, indices or commodities can gap meaning that the price moves to quickly. With guaranteed stop loss order gapping doesn't happen, the provider 'guarantees' the level at which you will be stopped out and this is why you are charged a premium for it.

Most providers will insist that you place a stop loss order with your trade to protect both you and them. This is usually placed automatically on trades opened (which is why it is sometimes referred to as a computer generated stop), however you can adjust this stop loss order level anytime. Note also that markets have a minimum distance from the current price where stops will be accepted. You can, of course move the stop further away from the prevailing market price provided your account has sufficient margin. We discuss the different type of stop losses and their uses in this section.

Q. How does leverage affect my trading?

A: To simplify this let's consider forex. In forex trading, if you are using 1:1 gearing, and your trade moves 3%, your account goes up or down 3%. With 5:1 leverage, when the trade moves 3%, your account changes 15% With 10:1 leverage, your account will change 30%. The same is true for margin trades in spread betting/cfds.

In general how this effects traders is the emotional reaction a trader has because such a large percentage of their account is on the line with greed and fear being the usual reactions.

How this applies to the technical aspect of the trade is that to follow proper money management, you will be forced to really tighten your stops. Higher leverage basically means a larger position size. To keep a maximum loss of 2%, you would need a really tight stop.

However, it is important to make sure that you are not placing a stop loss just because that point is where you are not willing to lose more money. You need to make sure you are looking for a support level, then determining the amount of money you are willing to risk or lose if you make it to that level, then set your share size accordingly. Make sure you don't just pick a spot and say 'well here I will be losing $100 so I need to make that my stop loss'.

At the end remember leverage is not what spread betting providers will allow you to use, it is what you decide to use.

 ...Continues here - Position Sizing: Amount to Risk per Trade and the 2% rule

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