In my previous article I showed you how spread betting need not be as risky as it is often portrayed to be. No more risky, in fact, than traditional share dealing… if done right. But risky it is, unless you place small bets on low priced equities or you use stop orders as described here.
The traditional view of stop orders is as standing orders that you place with your stockbroker or spread betting provider in order to stop a loss before it gets too big to handle. Without a stop order, your £10-per-point spread bet on the FTSE 100 index at a price of 6000 would theoretically put £60,000 of your money on the line, which could place your spread betting account at grave risk.
However with a stop order placed strategically to get you out if the index falls below 5900, your risk would be limited to a much more manageable £1,000. Take note, though, that this is only strictly true if your broker allows you to place a guaranteed stop order that will not be liable to price slippage.
Stop Orders to Secure a Profit
When limiting your risk as described in my previous article, by placing a small bet on a low priced equity, you might think that a stop order is not necessary. And you’d be right; until your bet moves into profit.
Suppose those HMV shares that you bought at 10p-per-share subsequently doubled in value. You could then place a stop order at the original 10p level, thereby assuring your exit at least at break- even. Looking at this from a different perspective, your newly-applied stop order has neutralized your original risk, so you can afford to place a new additional bet – on the same share or another prospect – at no greater risk than that which you were willing to take in the first place.
Now suppose your HMV (or other) shares move even further into profit. You can trail your stop order – always upwards, never down on a long position – to lock in more and more of your accrued profit.
Not All Stop-Outs are Good Stop-Outs
All good financial traders will tell you that you should run your profits and stop your losses, and that your first small loss (before it becomes a big loss) will be your best loss. It may therefore be tempting to position your stop orders very close to the prevailing market price, so as to get you out with the smallest possible loss.
The downside is that tight stop orders can trigger easily on minor fluctuations, and each stop-out will cause you to lose a little money on the bid-ask spread as well as tempting you to re-establish your position on every stop-out. You can save yourself a great deal of effort (and money) by placing your protective stop orders at a sensible distance. But determining the right stop distances can be as much art as science, so you’ll need some practice in order to make your stop placements perfect.
About The Author
Tony Loton is a prolific trader and financial writer, and author of the book “Stop Orders” published by Harriman House.