The Costs of Guaranteed Stops
Sep 27, 2011 at 10:57 am in Risk Management by
In the past few years I’ve written extensively about what I regard as ‘the most important weapon in a trader’s armoury – the stop order. I am sometimes asked about whether guaranteed stops are worth the cost of applying them, so I thought I’d take the time to outline what those costs are.
Let’s look at the obvious – and not so obvious – costs before we decide whether they are worth it.
Guaranteed Stop Premium
Some spread betting platforms charge a separate premium when you opt to guarantee your stop order. This premium will vary by traded instrument, from 2 points* (times your pounds-per-point stake) for the UK 100 Index to 20 points* on the EUR/SEK currency pair. On individual equities, the spread betting company may quote the premium in the form of a percentage such as 1% for UK Mid 250 Rolling Daily* shares.
* Figures from Trade Fair / London Capital Group at the time of writing
Wider Spread
Some spread betting companies don’t charge a separate premium, but instead they widen the bid-ask spread by an equivalent amount. For example: at the time of writing I can trade BT Group on the Cantor Index platform with a spread of 173.10 – 173.90, but checking the box to guarantee my stop raises my buying price to 175.30.
Greater Minimum Stop Distance
A slightly less obvious cost comes in the form of a greater minimum stop distance. Since the spread betting companies are guaranteeing to stop you out at the price you specify, regardless of how far the market price gaps up or down, it is perhaps understandable that they want to build in an additional margin of safety for themselves.
Tradefair requires a non-guaranteed stop order to be a minimum of 0.9 points away from the prevailing market price of BAE Systems, and a guaranteed stop order to be at least 14.5 points away. This greater minimum stop distances represent a real cost, but one that you pay (in effect) only if you actually stop out at the greater distance.
Higher Rolling Charges
Some spread betting companies, notably Shorts & Longs, offer ‘free’ guaranteed stops that are mandatory. It sounds great, but the last time I tried it I found that the overnight financing charges on this platform were up to ten times the cost of rolling charges on other platforms. So, at that time at least, those guaranteed stops weren’t exactly free after all.
Are Guaranteed Stops Worth The Cost?
It depends what your trading, and how you’re trading it.
- If you’re diversifying your risk by placing many low-stakes bets on low-priced equities, you probably don’t need to use guaranteed stops at all.
- If you’re betting the farm on a single four-digit stock index or commodity trade, you might not sleep soundly without the peace-of-mind that the guaranteed stop gives you.
- If you’re day trading, any higher rolling charges won’t hit you at all, and if you always use wide stops then the minimum stop distances won’t figure in your cost calculations.
Tony Loton is a private trader, and author of the book ‘Stop Orders’ published by Harriman House.