Market Gaps and Slippage

Q. What is Gapping?


A: A gap is a break between prices that occurs when the price of a contract makes a sharp move up or down with no trading occuring in between and usually happens when a share or index opens the trading session significantly higher or lower than the previous day's closing price. It is known as a gap because the result is an empty space on a chart. Gaps can be created by a number of factors including regular buying or selling pressure, earning announcements, a change in an analyst's outlook or any other type of news release. Gapping can occur both on the up and downside. If a market gaps through a normal order, the spread betting order will be filled on a best efforts basis at first available price (not order level). Note that this won't happen with guaranteed stops where the stop loss order will be honoured by the spread betting provider even if there's gapping.

Let's take an extreme example. Example - let's assume you decide to short 10000 shares in ABC Pharmaceuticals when their share price is at £1, with an initial margin deposit of £500. The next day, ABC Pharmaceuticals surprisingly discover the cure for cancer, and their share price explodes to £1000 per share. Not only have you lost your £500 stake, but you now owe £9,999,500 pounds. You'd hope that your supplier would terminate your bet before it got to that stage, but if the market 'gaps', there's not a lot you can do. Some spread betting providers offer 'guaranteed stop loss', or 'controlled risk'. You pay a premium for this service, but if your bet loses, it is guaranteed to be terminated at a pre-arranged loss, regardless of market conditions.

Q. What happens if the market gaps through my stop?

I'm looking at opening an account in the next month or so but have a quick question about stops at Capital Spreads. If for example I have a stop on a trade and the market gaps through it will my stop be activated at the next closest price or does the fact that it gapped though my stop mean that the trade will stay open and in effect mean my losses just keep mounting until I can take it out manually?

A: In financial spread betting, if a market gaps through a stop level, you will be filled at the next best price after your stop was triggered. This means you will still be stopped out if the market gaps from a level above your stop to a level below without ever having a trade done at your exact stop price. Naturally, in fast or thin markets, slippage will occur, and this is the case with any spread betting firm.

The majority of index and forex pairs are traded on a continual basis so there is less risk of gaps between trading sessions implying that that there is less likelihood of the price gapping against your position. This doesn't mean that gaps aren't possible but at least you are able to enter or close positions at any time.

Q. What is the difference between Gapping and Slippage?

A: Slippage refers to a particular instance when your stop loss does not get filled at the exact price you ordered but slips a little and you get filled at a lower or higher price. Every regular spread better gets caught by this at some time, it is the one of the annoying part of setting opening orders and it can ruin a trade.

A gap on the other hand is when the market jumps 100 or 200 or even more pips overnight resulting in your stop loss being missed and your trade closed at the much higher or lower price than intended. If you are dealing in UK or foreign equities and letting the position run overnight there will always be a risk that when the stock exchange re-opens the price would have moved against you. You cannot avoid this risk but you can minimise any losses by keeping an eye on the forward calendar and perhaps by using a guaranteed stop.

Both 'Gapping' and 'Slippage' are important to recognise as you can easily blow your account if you are heavily overgeared.

Q. My FTSE short was closed after-hours but during market hours the index had got nowhere near the stop?

I've just lost about £200 on a £2pp FTSE short opened on Thursday. Now the thing is, this was triggered at just gone 8pm on Friday night - during trading hours it's came nowhere near the stop. I would understand if this was a bet on FTSE futures, but it wasn't, just a straight quarterly bet, so why is it swinging around so much out of trading hours? Surely it should be roughly tracking the actual value, therefore not moving much when out of hours?

A: I'm afraid futures move quite wildly out-of-hours...

The only logical protection is:

  1. Years ago one of the spreadbetters offered stop losses which only operated during the last 5 minutes of the trading day so you could sell out when the trend moved against you but you remained unchallenged by very short term spikes.
  2. Literally calculate separate levels of suitable stop loss for day trading/Overnight trading and Overbank holiday weekend trading.

Q. Have you ever noticed that when you have a small-cap position with them, the price to close is significantly adrift from the market price?

A: The percentage spread they add on top of market spread is a published fixed percentage - and can thus be calculated in advance of requesting a quote - (e.g., Cantor add 0.6% of share price, on top of current market spread, for a near quarter bet, and 0.8% on a far quarter bet), so they are not going to get away with quoting an excessive spread without being challenged.

The position of the quote (i.e. where it is centered in relation to where current market price now is) is something they will be forever shifting, in line with future expectations for each stock. That is normal. If the stock price is regularly climbing fast, the quote will likely be further ahead of current price than if the stock is climbing less fast, and will likewise be skewed to the downside when the stock is falling if such falls look like continuing in a way that shows in the futures market for that stock or its sector.

Again, this is normal.

They are free to position the quote wherever they wish and free to move it wherever they wish, whenever. The judgment they exercise in doing so will likely include logarithmic formulae relating to both the relevant futures market and to the weight of betting. If they wish to also incorporate a degree of craftiness specific to a particular bet, and had the time to do so, they are free to do that too although that might then open up arbitrage opportunities

Q. How does the stop-loss thing work? I've read the website but don't get it. I mean, if you buy a stock at €1.00 and set your stop-loss at 99c, then, surely we'd all be doing it and making a killing!

A: For a stock trading at €1, the spread you might be offered could be: .98 - €1.02

So you can buy at 1.02 and sell at .98 which means the spread has to move to 1.02 - 1.06 before you breakeven on a buy. If you were to have a stop loss at .97 and markets are as likely to move up a cent as down a cent in the short term then you have about a one in five chance of doubling your money, additionally most spread betting sites don't guarantee your stop loss will kick in at the stop loss price, its on a best efforts basis (this is known as slippage).

Q. My first spread bet is now -£151. Not liking it so far...but its a December bet anyway so a few months to go.

A: Sorry that happened but you need to have a trade plan...

I met a guy once at a free seminar who told me about his trade plan and I have to admit that since applying it to my spreadbets, I lose less and make more. It's truly simple - take your trading pot, that is to say the amount of money, hypothetical or real, that you intend to use for spreadbetting and then plan to lose no more than 3% of that pot on any one trade. And never be more than 15% invested at any one time.

Let's say it's a 5K that's £150 risk on every trade and you might have open up to 5 trades at one time.. You could then lose all 5, safe in the knowledge that you will live to fight another day.

So take a look at that £151 in relation to the size of your pot and go from there, do not just cross your fingers and hope it comes good.

If you don't mind me saying so, there is a danger in assuming that a longer timeframe means plenty more time to come good. With leveraged positions that logic is best avoided in my opinion, as losses can grow dramatically fast (ten times faster than with shareholdings) and quickly swamp your account. My own approach in such situations - unless there is genuinely some factor which will (not might) bring things quickly back into profit, is to reduce my stake immediately. You can always increase it again later.

Comment by Dan; I'm very sceptical of stop losses, either a company is good or not.

I have a lot of sympathy for that view Dan, but then let us assume that you have a sizeable holding in a mining company. They have made some good strikes, the analysts' results look very encouraging, the smelters and concentrators are available, the infrastructure is in place and the market for your metal is strong.

Your mining company then decided to make a cash call on investors to fund the commercial extraction - after several months all is going well then kapok Mother Nature steps in and deposits a shed full of rain on the mine site, such as the five foot of rain that fell on Washington in 24 hours!! As a result, flooding affects several working faces - production is stopped, That impacts on the bottom line and earnings are revised downwards - kapok your mining stock falls 50% or more, only to find that you have a labour dispute on your hands. Then, I would feel happier with a stop loss, simply to limit the downside!

A great deal of money was lost in the last big market crash as some investors believed that the shares were still sound and kept on holding, even though the market kept on falling, so stop-losses were not operated.

 ...Continues here - But when should I Sell?

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