Using A Stop To Exit A Spread Trade
Stop losses, this is what will stop you losing thousands if things move against you. Setting your stop loss effectively allows you to set how much money you want to risk in each trade. This means your losses are limited and your profits are potentially unlimited – very generous! A normal stop loss is typically free, but you will pay extra for the other ones available by way of a larger spread (although Ayondo does offer free guaranteed stops).
Whenever you enter a spread trade, you should always enter a stop order to protect your capital, just in case the market doesn’t agree with your analysis. I advise moving your stops closer to the market as your trade goes into profit. This gives you more peace of mind knowing that your ‘paper’ profits will not all disappear if the market turns against you suddenly.
If you will be away from your screen for days (example: taking holidays), either close out all positions, or place sensible stop-loss orders. Of course, you may miss the rare big move, but, like the buses, there is always another one coming along. Don’t get hung up on missed opportunities.
One good tactic to use when your trade is in profit is to place a Limit Order to close out at your target price, but to also have in place a protect-profit stop in case the market doesn’t reach the target. You would enter both orders on an OCO (One Cancels Other), so that you are not whipsawed! When one order is filled, the other is automatically cancelled.
Make sure you know where to place your stop losses. If you set it too close all you are doing is handing over your cash to the spread betting company as it will trigger off during normal daily movements. Look at the volatility of the market, choose a level of risk you are happy at and then set it appropriately.
As an example, let’s have a look at a trade in the Dow Jones:
Let’s say the market is at 10,200 in February and your long-term target is 10,750. You are in at 10,200, and you place your stops. You are confident the market will hit your target, but since this is a game of probabilities – it may not, and you have to plan for this outcome. As the market moves in your direction, you move your trailing stop to just under the most recent significant low (as shown).
There will only be one of three outcomes: Either your target is hit, making you a 550 point actual banked profit (£550 per £1 bet), or the market falls short of target, taking you out at your stop. In this example, the market went above your target – giving you that nice third outcome!
Your actual profit here was £800 per £1 bet. But what if the market continues down and moves through your entry price – are you glad you moved your stop up? Of course you are. Without that stop, you would have seen a big profit vanishing from sight.
Or, the market, after taking you out at your stop, moves back up – are you kicking yourself you got out ‘too soon’? Well, if you are a good trader – definitely NO. Because you are trading a plan with solid technique, you may spot an opportunity to get back in at a low-risk level later (or you may not). Remember what I said earlier about emotions and discipline? Each trade is a new event – try not to cling on to damaging emotional responses to upsetting past events (such as missed opportunities).
I would rather have an £800 profit in the bank (by sensible use of stops) than an indeterminate profit or loss (by not using stops, or having them too far away). I hope you feel likewise. If you follow this procedure in all of your trading, you are assuming the correct attitude of treating trading as a business – not as a place to get your kicks, but a place to apply serious rules in the search for profits.
I will say that stop placement is a bit of an art. I have not found a formula that works like clockwork in every situation, although many have tried to come up with such a formula. I believe that only experience can give a trader a ‘feel’ for this. As always, use common sense when placing stops.
When first in a trade, you could use a ‘money stop’. This will get you out by losing a pre-determined amount of cash, if the market moves against you. Say you are betting £2 a point on the Dow and are in at 11,239 on an upbet. You decide to risk £100 on this trade (being no more than 5% of your account size). This is 50 points, so you would place sell-stop at 10,739.
This isn’t a bad method, and may well suit you. It pays no attention to chart points, of course. That is not necessarily a bad thing, since many obvious chart points act as buffers and not move-enhancers! There are big traders out there who ‘fade’ a market when an obvious chart point has been hit – they will buy when small traders are selling to test the strength of the selling. Sometimes, there is no follow-through, and the market rallies again.
I try to avoid setting stops where everyone else has them to avoid these problems. These points are usually just under previous lows, or just above previous highs (a glance at the chart will give these away).
You need to know that some spread betting firms will automatically place a protective stop order for you when you enter a market. Because these are usually not ideal, you need to modify these just after the trade fill is made.
‘Even being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the trades where he has been wrong’. – Bernard Baruch, Legendary Early 20th Century Financier
There are many different types of stop loss to choose from. You may have heard the term “guaranteed stop loss” coined. With a normal stop loss the markets can “gap” against you, this means the market is moving quickly and your trade can’t be filled quickly enough causing it to pass your stop loss level – a guaranteed stop loss will prevent this from happening.
A trailing stop loss is a stop loss that will automatically stay a set amount of points behind the market price. This effectively locks in your profit on a winning trade. These are no substitute for watching the market. If a firm doesn’t offer a trailing stop call them up and they can move up your stop manually or do it yourself online.
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