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.
Expanded Situations Where Guaranteed Stops Are Useful:
- When You Can’t Afford the Loss:
Protect against large potential losses that could significantly deplete your trading account, especially with leveraged or high-value positions. - When It’s Nearing the End of the Trading Day:
Price gaps are most likely to occur overnight or over the weekend. Using guaranteed stops before the market closes helps protect your position from sudden and unpredictable movements. - When a Position Has Moved in Your Favor:
As profits accumulate, locking in gains with a guaranteed stop ensures your progress is protected from a reversal. The one-way ratchet effect of guaranteed stops can solidify your advantage. - When You Can Guarantee a Profit:
Use guaranteed stops to lock in a profit rather than securing a loss, particularly when the trade has moved significantly in your favor. - During High Market Volatility:
High volatility in the market increases the likelihood of sudden price swings. Guaranteed stops prevent slippage and ensure execution at your set level. - When Spread Betting Stocks Involved in Merger & Acquisition Talks:
M&A announcements can trigger drastic price moves. A guaranteed stop helps mitigate the risks of unexpected gaps. - Ahead of Upcoming Trading Updates or Corporate Actions:
Corporate events like earnings releases or dividends can create substantial overnight price movements. Guaranteed stops shield your position during these uncertain periods. - When Trading Commodities:
Commodities often experience sudden and unpredictable swings due to geopolitical, weather-related, or economic factors. Guaranteed stops provide an essential safety net. - When Trading on Risky Exchanges:
Markets such as Russia or China carry unique risks, including regulatory changes and political instability. A guaranteed stop minimizes the impact of unforeseen events. - When Trading AIM Shares and Small Caps:
Small-cap stocks or AIM shares often lack liquidity, leading to exaggerated price movements. Guaranteed stops help control these risks. - When Trading in Conditions of High Uncertainty:
Whether due to global crises, breaking news, or extreme market conditions, guaranteed stops provide peace of mind and limit risk exposure. - For Instruments Traded on Weak Fundamentals:
Use guaranteed stops when trading assets with poor fundamentals that are heavily influenced by technical movements to mitigate downside risks. - Any Time You’re Concerned About Risk:
Whenever you feel uncertain or uneasy about the potential risk of a position, a guaranteed stop can act as an extra layer of protection.
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: Everyone is trying to sell you something these days, and that “something” is usually insurance. Have you ever tried walking out of a mobile phone shop with your new phone and no insurance policy? Have you tried owning a dog without being bombarded with advertisements for the “essential” pet insurance that somehow wasn’t as essential when your parents owned pets?
Sometimes your possessions need to be insured, and sometimes your trading portfolio does too, but not every possession or trading position needs to be insured. In this article I’ll argue that in life and in trading you only need to insure the risks you can’t afford to take.
I’ll start with a “personal finance” analogy, which will turn into a trading lesson before the end of the article.
The Problem with Traditional Insurance
For most customers, insurance is a losing proposition with a “negative expectation”; it has to be so in order for the insurance companies — who hope to take more in premiums than they pay out in claims — to turn a profit.
If you added up all of the insurance premiums you ever paid over a lifetime on your car, home, illness, possessions etc., for most of you the total will be more than you had ever claimed back. Yet most of us consider insurance to be essential protection against unexpected events, and it’s an easy sell for the insurance companies who offer to “protect your bubble”… at least until it comes time to actually make a claim.
Not only do you almost always get less back than you paid in, but in the meantime the insurance companies have hold of your cash which they can “invest” wisely.
The Lure of Self-Insurance
Some people choose to “self-insure” by not paying the insurance premiums. They simply take the hit themselves in the unlikely event that something goes wrong. Each time you buy a hi-tech gadget, simply deposit the insurance premium in a bank deposit account rather than handing it over to the salesman over time you should come out ahead… even if you do occasionally lose a gadget. Let’s face it, after 18 months of ownership you’ll probably fork out for the new higher-tech model anyway, and consign your original now-obsolete model — on which you had taken the ‘essential’ 3-year protection — to the bottom drawer never to be seen again.
This approach works for those risks where you can afford to take the occasional hit. Most of us can afford to replace a £300 phone occasionally, can’t we? And the £100 saved from not paying the insurance premium would help us to do just that. Do we really need to provide the AA, RAC, or other motoring organisation with a continuous revenue stream when we can pay for a tow truck only when we really need one? It’s a little different when we consider the potential liability of knocking someone down in our cars, or the cost of rebuilding our detached houses. Some risks we simply can’t cover from spare cash. In those cases, and unlike most gadget insurance, the typical motor vehicle or home insurance premium is usually very small compared with the amount of cover.
My point is that it is probably most cost-effective to insure only those risks which we can’t afford to take.
Stop Orders as an Insurance Policy
When you apply a stop order to an open position, you run the risk of stopping out and having to re-enter the position at a higher price (or bank the loss forever). That’s the price you pay for insuring that you don’t hold all the way down to zero. If you guaranteed the stop order, you will have paid for the privilege by paying an additional fee that is not unlike an insurance premium.
Guaranteed Stops usually 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!)…
Next time you purchase a phone, computer, house, car or pet think carefully about whether you really need the “essential” insurance. You might also review your existing insurance commitments in order to find out, for example, whether you’re still paying for travel insurance when you never actually go anywhere. Likewise, next time you open a new spread bet position, think about whether you really do need a stop order. Are you attaching a stop order merely out of habit, or because the potential risk really is too big to bear. Note: when placing a £100-per-point on the FTSE 100 index at a price of 5000+, this risk is definitely too big to bear! By all means use stop orders as an insurance policy, but only insure the risks that you can’t afford to take! Everybody talks about 9/11 and 1987 but a simple piece of mathematics shows that continually paying away the guaranteed stop premium on every trade would soon negate even the worst fall in the history of the modern markets.
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.
