Situations where Guaranteed Stops are Useful

Q. Should I be using Guaranteed Stop Losses?

A: Guaranteed stop loss orders protect you against overnight price movements or gapping - when a price jumps past a stop loss level. So when considering their use ask yourself: Could the market jump by much more than the guaranteed stop-loss level? If you know your stocks well, you will have a feel for the likelihood of jumps of different sizes - for example, how often Barclays has fallen in 10p increments. Guaranteed stop losses will force an order to go through at a the specified price even if the market price gaps past it. Note that spread betting companies typically only offer guaranteed stops on the most liquid stocks (i.e. don't expect to get a guarantee on a penny stock).

The guaranteed stop loss order charge with IG Index for instance is 0.3% so for $10,000 worth it is $30 plus around $8 in and $8 out that's $46...so it will pay for itself only if the market gaps more than 0.3% on you. Note that on Indices GSLO cost 3 - 5 extra points to trade. Note also that when you open an account you have the choice to either open it as a 'Limited Risk Account' or a 'Normal Account'. A limit risk account will force GSLOs on all your trades included index and forex trades (you don't want that).

Used properly and in the right situations a guaranteed stop loss order is a nice good risk control mechanism. Not only does it force you in entering a stop loss when you place the trade but it guarantees the stop loss level. You can even creep the guaranteed stop loss level up if the trade is going your way (thereby guaranteeing you a profit while reducing the amount of margin on other outstanding margins) and still allow the stock to come back a bit to let profits run.

Occasions where guaranteed stop loss orders should be considered include -:

Spread betting stocks involved in Merger & Acquisition Talks.
Upcoming trading update or other corporate actions
Trading in very high volatile conditions.
Spread betting commodities (which tend to have wild sudden swings).
Trading shares in risky exchanges (Russia, China..etc).
Trading AIM Shares and Small Caps.
Trading anything traded technically that looks a bit ill fundamentally.
Any time that you are worried by the risk.

Guaranteed stop losses also come in useful for biotechs, miners and oilers, where shocks can wipe 50% off the price before you have had a chance to trade. Take CNE (Cairn Energy Plc) as an example. As it starts drilling in Greenland the price will be volatile (I believe). Finding oil could be transformational but if they start with a duster (no oil), the price will fall sharply. The guarantee stop can protect you from that. Wonderful.

Be warned though that guaranteed stop loss orders are not a silver bullet - depending on the stock and the spread betting provider, the closest you can get is about 5 to 10% away from the current price so you will have the potential of losing up to 10 per cent of your initial outlay before the guaranteed stop-loss kicks in. But then you don't want to use a guaranteed stop loss 5% away from the market depositing just the minimum 10% margin for the trade. You get hit like that and there goes 60-70% of your outlay plus brokerage. Some spread bets only require a 5% margin - you get hit and there's a margin call coming your way! Not very good risk and money management...

Q. But how secure are guaranteed stop loss orders in reality? Won't I still be slipped out in a 'force majeure' scenario?

I'm wondering how secure guaranteed stop loss orders really are. For instance, I work a 9-5 job so I would put in a trade early in the morning with a guaranteed stop loss order in case something went wrong and then come home to see how it all went. If the stock went bad I am hoping that I would be automatically out of the trade at the guaranteed stop loss level I put in.

Is this how it works? I'm guessing a guaranteed stop loss is exactly that, guaranteed. BUT does the market have to be open and operating normally for a guaranteed stop loss to be executed? For instance suppose say there is a sharp downtrend adjustment in the price of a share, let's say as a result of an event announced over a weekend, then the price will drop sharply at the opening on the Monday morning - will my position still be covered and stopped out by the guaranteed stop level or will this be a 'force majeure' event due to the extreme market movements and thereby subject to best execution?

A: A guaranteed stop should theoretically take you out of the market at the agreed price whatever happens to the market. If we see a sharp downturn also known as a gap you should still be knocked out the market at the guaranteed stop. So a 'normal' Stop Loss is one that is subject to 'Force Majeure' events such as the one you described i.e. Market Gapping (although different spread betting providers may have different policies, see below). A Guaranteed Stop Loss will close your position at the stop price whatever happens. Paying the extra premium at the beginning shoud guarantee you your fill level. So even if the stock went into liquidation you should still be filled at your stop level.

Be warned however that different spread betting firms may have different policies as regards 'Force Majeure' and therefore I've taken the liberty of sending a few e-mails to the big boys querying this point (replies below) -:

IG Index: 'I can completely understand your concerns and why you have them, however please be assured that at IG a Guaranteed Stop means exactly that. When you open up a position with a Guaranteed Stop, you do pay an extra premium for this facility. But we will always honour this type of stop and close a Guaranteed Stop position at the specified Guaranteed Stop level.'

Cantor Index: 'Force Majeure' we do not rule out as it is part of our terms and conditions. It has very rarely been used by Cantor's even in the current volatile climate with shares. 100% movement in a stock may well make us use 'force majeure'.

City Index: At City Index, our Stop Loss Orders, once triggered, are executed at the first price reasonably available, which is normally the order level. However, our Guaranteed Stop Loss Orders, once triggered, will be executed at the proposed execution price regardless of any gapping. City Index Terms (in particular clause 17.4 of our General Terms) describe orders in details and make clear that Guaranteed Stop Loss Orders will be executed once triggered at the order level regardless of underlying market gapping, hence the small charge levied for this guarantee.

Q. What is the catch with using Guaranteed Stop Loss Orders?

A: Well, for a start they carry a hefty premium which is usually levied in the form of an extra point or two on the spread. Secondly, spread betting firms typically will only allow you to place guaranteed stops on the most liquid stocks; for instance CityIndex currently limits guaranteed stop loss orders on FTSE 100 stocks (although you can of course place a normal stop loss order on all stocks) whilst other providers may limit the maximum amount per point you can place on a guaranteed stop loss order (for instance ODL Markets limits the maximum stake to GBP5 on a guaranteed stop).

Also, most providers will require you to place guaranteed stop orders a set percentage away from the current market price. For instance the last time I checked with CMC I was informed that their guaranteed stop loss (GSLO) orders can only be placed by phoning their dealers - and even then CMC will require that you place them at a minimum of 5% from the market. Think about it most spread betting margins are at 10% and if your guaranteed stop loss is hit, voila, there goes 50% of your outlay - not very good money management. At 5% margin you lose the lot (if you are using full gearing which you shouldn't!)...

Q. Is there a company out there that offers guaranteed stops on all markets?

A: My understanding is that IG Index offers guaranteed stops on all markets that can be sold to open. However, some markets cannot be sold to open due to stock borrowing restrictions in the underlying market. You just need to place a a tick in the Guaranteed stop box, when opening a new position. Note also that the minimum stop distance will vary, and may be subject to changes during volatile market times.

Note that a guaranteed stop carries an extra charge in terms of a wider opening spread.

...Continues here - Trailing Stops

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