As I suggested in my getting started with stop orders article, the purpose of a stop order is not solely to stop a loss. This is why I try to avoid the more usual and more limiting terminology of “stop-loss order” when we explain how to spread bet.
A stop order is just as useful as a mechanism for securing a profit, and (when trailed) as a mechanism for securing increasing profit. When securing your profits using stop orders you are, in fact, neutralizing risk and freeing up risk capital that you might use for pyramiding additional funds into a nicely-performing position.
Let’s look in turn at securing increasing profits, neutralizing risk, and pyramiding.
Securing Increasing Profits
When the stock you bought at 100p rises to 120p, a stop order placed at 110p will ‘lock in’ 10% of your 20% paper profit without you having to crystallize the profit by selling out too soon. The price might go higher, and if it does then you can trail your stop order in line with the rising price. When the price moves to 130p – congratulations – your stop order at 120p will lock in 20% of your 30% paper profit. When the up-trend comes to an end, you should be left with the amount of profit secured by your stop order.
Another way of looking at this is that your rising stop order is helping you to neutralize risk. When you opened your trade at a price of 100p your initial protective stop order at 90p (for example) gave you a £10 risk on a £1-per-point spread bet. When the price rises to 110p and you raise your stop order to 100p your worst-case result will thereafter be an exit at break-even, so in effect you have neutralized your original risk.
Since you were willing to take a risk of £10 in the first place, and you have now neutralized that risk (and more), why not re-stake some of the freed up risk capital – in your winning stock or in another good prospect – using the process known as pyramiding? You could have a double-size position working for you with no more overall risk than the risk you accepted on your original position at the outset.
Original position bought at 100p, stop order at 90p, £10 risk.
Original position bought at 100p, stop order now at 100p, no risk.
2nd position bought at 110p, stop order at 100p, £10 risk.
Nothing in Life is Guaranteed
This apparently low-risk pyramiding process is only truly risk-free if your stop orders are guaranteed by the spread betting company – so do check. And you’ll only come out with a profit at the end if you secure your profits faster than you pyramid them, so you might think about not establishing your second position until you can do so like this:
Original position bought at 100p, stop order now at 120p, £20 secured profit.
2nd position bought at 130p, stop order at 120p, £10 risk.
Overall secured profit = £20 – £10 = £10.
Subject to your stop orders being guaranteed, this really is a secured profit, and with your two positions in play you will henceforth benefit double from any additional price increases.
About the Author
Tony Loton is a prolific trader and financial writer, and author of the book “Position Trading” published by LOTONtech.