Should I Pay For Guaranteed Stop Orders?

Published by Filipe R. Costa on Mon, 19/12/2011 - 17:38
guaranteed stop loss

Most traders that are new to spread betting and CFDs usually express some concerns due to the widely advertised warning stating that a trader can lose more than what he has in his trading account. That is a true statement but it is not new or specific to spread betting.

Trading on margin is not a new way of trading nor it is specific to spread betting. Traders have been trading on margin with brokers since long ago. As long as they carry positions that are greater than their account funds, they can end losing more than what they have in their accounts.

Why the recent concern?

As a margined product, spread betting gives leverage to the trader as any other existing margin trading product. The constant development of technology makes it possible for any broker or spread betting provider to close positions automatically when a certain level is reached instead of doing it manually. This means that instead of a leverage of 2 or 3, they can now give 10, 20 or even more. With such a leverage level, in just a matter of seconds, a trader can see all his funds vanish and if prices change in a sudden movement it can happen that account funds are not sufficient to cover the resulting loss.

How can I protect from losing more than I have?

The best answer for this question is: guaranteed stop orders. A guaranteed stop order, as the name suggests, guarantees the price at which a position is stopped, or closed. You know with certainty how much you’ll lose if things don’t go as expected. The problem is that there is no such thing as a free lunch and guaranteed stop orders come at a cost, and sometimes it is heavier than traders can support.

Capital Spreads, as an example, offers a 1-point spread to trade FTSE100. If you decide to place a guaranteed stop, you will be charged an extra 2-points and have to set a stop that is at least 30 points away from market price. The spread is then three times greater and you will have to be willing to lose at least 30 points. This is a double cost: increased spread and increased potential loss. If we consider equities instead, then things will become worse. FTSE 100 shares will imply an additional 0.5% charge in the spread and a distance of 5% to market price. If we consider more illiquid shares, then things become even worse.

The cost of a guaranteed stop will make you think twice. If you like to trade frequently, then you just can’t pay such price and probably you don’t want to lose that much in each single trade. If you trade infrequently, then you may be more willing to pay for the increased charges. That’s because you are probably seeking for a greater profit that can better absorb the extra spread.

Identify your trading pattern before deciding

When deciding whether to use or not a guaranteed stop order you should go through the following matters:

  • First of all, you should identify the markets you are trading in: more on equities, on indices, forex? Some markets are less risky and move more smoothly. That’s the case for indices when compared with equities. Certain equities also move slower than others. Markets with higher volume are easier to go out without any slippage.
  • Second, are you carrying positions over night? If the answer is yes, then a second question arises: do the markets close? Forex markets deal for 24-hours non-stop but equities close at normal market hours. If you hold Vodafone over night and it releases a profit warning just before the open, then it can open without any slim chance of your stop being filled at the pre-defined price.
  • Third, how much leverage are you using? One, two, ten times? The less the leverage, the less the probability of occurring nasty things like having to put additional funds into your account.
  • Fourth, how are markets moving? Sometimes there are certain political, economical, and other factors that bring too much volatility into markets. Under increased volatility situations, the probability of stop slippage is higher.
  • Fifth, are you a day trader? If you are, then you seek for smaller movements and always close positions before a market closes. You can’t afford any extra spread costs. And do you really need a guaranteed stop?
  • Sixth, is your provider really good and trustable? When it comes to closing and opening positions there are certain providers that deal really fast while others just take too much time such that slippage occurs more frequently.

After answering and reflecting on each of the above items you will get the best answer to the question of using or not guaranteed stop orders. Each case is a different one, and without analysing all those aspects one cannot say what is the best curse of action. I just can say that, if you don’t use too much leverage and don’t carry overnight positions in infrequent traded equities or markets that are expecting certain events that usually increase volatility, then you will certainly be better by just using a normal stop order and enjoying a lower spread.