Guaranteed Stop Losses & why often its a Bad Idea to Use Them
It probably makes sense, especially in somebody’s first year, and particularly where he is unable to constantly monitor the pc charts/news/action to use guaranteed stop losses. But the reader needs to be aware that it is an expensive form of protection; thanks mainly to those unexpected and unwanted ‘excess’ charges which kick in unnecessarily whenever a transient spike occurs or is engineered. Guaranteed stop losses also tend to kick in far more often than the ‘real’ situation of a share price collapse. What’s more, the spread betting companies know that when the annoyed punter has been kicked out of a bet by one of these many false alarms, she/he will quite likely reopen the bet – paying the added spread again each time. I do feel that users should in my opinion develop alternative protection regimes, once they’ve got a feel for how everything works.
Setting a stop or a limit is free of charge but unfortunately there is no guarantee that you will be stopped out or filled at the price you require. A guaranteed stop does what it says – guaranteeing that you will be filled at your designated price even if the market jumps through it. But unlike with ordinary stops, you have to pay for the peace of mind the guaranteed version brings.
You can think of the charge for the guaranteed stop loss as an additional insurance premium, debited via the greater quoted spread. Not an ideal analogy, I know, as insurance merely compensates for damage rather than stopping the setback from happening. This means that over a lifetime the insurance companies will always win as only they have a good idea of the true odds.
But it’s an insurance policy with an agreed ‘excess’ (in the form of the portion of loss that has to be borne due to whatever distance the GSL is built in). You have to consider whether routinely paying the premium AND occasionally falling foul of the excess whenever the stop loss is triggered – either by the real dive which you wanted protection against, or by the all-too-frequent momentary spikes in share price movement is justifiable in relation to your own circumstances.
With spreadbetting there seem to be two camps, those that think you are a muppet to trade without guaranteed stop losses and those who frankly – don’t like them. I confess I don’t like them and rarely use them. Now, don’t get me wrong, I totally believe in stop losses but I simply don’t see any point in paying the additional premium for a guaranteed stop. While a spread betting firm will provide a guaranteed stop on an equity bet, this will not be any closer than 10% away, a substantial distance for a share. And it will cost you 0.5% of the share price, making it that much harder to profit from the trade.
In fact from my chats with market makers they love “guaranteed stops” as they make a fortune by charging an extra spread, imagine if every time you placed a bet you paid 1-2 points extra. If it makes the spread firms a lot of extra money then as a punter over the long-term it probably means you should leave them. Even Conor Ringland, head of E*Trade Professional, doesn’t recommend guaranteed stop-losses. “I don’t know a broker who doesn’t add a premium, typically of between 0.3 and 0.75 per cent, and it’s paid in advance, like an insurance premium,” he says. “On a £10,000 trade, that’s between £30 and £75, which you pay even if the trigger level isn’t reached’. While some brokers admit that guaranteed stops might still be worth considering for illiquid stocks or in extremely fast-moving markets, a sounder risk strategy is to trade smaller amounts in volatile markets.
All logic goes out the window when you place a trade with real money and those emotions come in
Again, don’t get me wrong, you absolutely should not trade without a stop loss in place. Stop-losses are vital for many traders who take big positions with gearing, their purpose is to preserve capital, and I recommend that all traders and investors think first about retaining their capital rather than increasing it. If you are not convinced they are a good idea, look at it this way – the primary aim of the spread better is capital preservation. This is far more important than chasing huge profits. Some trades will be profitable and some won’t. A stop loss will ensure that the unprofitable trades are closed quickly and not allowed to cause any terminal damage to your trading account.
However, it’s important to note that stop orders often come into force when the market is volatile and share values are moving rapidly, and there is no guarantee that the trade will take place at the level you stipulate. For example, say you owned shares currently priced at £1, and you put in place a stop-loss order that meant they were sold at 95p. When the price reached 95p, the broker would immediately execute your sale at the best available price in the market – but if the market was very volatile, the best available price might already have fallen to 92p, even within that short timeframe.
I do use normal stops on most of my positions, though I try to keep them quite a way down to avoid being triggered on shakes and spikes down. This I do by finding the x-day ma that the price appears to “best fit” at it’s low points (kind of a simplified Dr Elder method), then consider how far below this ma previous spike-downs have gone and then set the stop at the current ma minus the value of the previous spike down below the ma, minus a few more points. If this then takes my stop to far below my entry I don’t bother with it. Obviously I try to get in somewhere close to this ma. Occasionally I use guaranteed stops on more “speculative” bets that I am less sure about, but I don’t do these very often, so it’s rare for me to use them. I usually set the GSL far away from the buy point (and so put on smaller bets so I balance my absolute potential loss) but often close the bet before the GSL triggers.
However, I feel new investors should use Guaranteed Stop Losses until they have proved they can be successful investors (by consistently making money). Once good profits have been banked these then become the insurance (plus having both shorts and longs) to cover that unforeseen, sudden loss and GSLs can then be dropped.
To recap then; use a standard Stop Loss (SL) closing order on less volatile markets and stocks (FTSE/DOW), Do NOT set your Stop Loss Order too close to your opening one, or else you will get “Stopped Out” and lose money, LOCK IN profit as soon as you can by moving your Stop Loss order in the direction that locks in profit (depending on whether you have gone LONG or SHORT), and finally USE a Guaranteed Stop Loss (GSL) when trading in highly volatile markets etc. (Tech Stocks). Finally on Stop orders. Don’t use a GSL as an insurance on a trade that you are uncertain about. If you are uncertain, simply do not make that trade.