What is a stop order?
As we explained in the stops and limits section, a stop order (often simply known as a ‘stop’) is an instruction to your broker to deal when a market price reaches a particular level that is less favourable than the current price. In other words, a price level above the current market if you’re ‘buying’ or below it if you’re ‘selling’.
Many spread betting providers offer a variety of stops that you can use both to minimise your risk and, in certain situations, to lock in a running profit.
A stop-loss closes a bet when a specified loss is reached
A stop-loss order is the most basic type of stop – an instruction for your bet to be closed when a certain price is reached. This is an important way to protect yourself if the market moves against you: you simply attach a stop to your bet at the level beyond which the size of the loss would become unacceptable to you.
Shares of ABC are trading in the market at a price of £37.00. In spread betting terms this is represented by a price of 3700, where each of those 3700 points represents one penny of the share price.
Let’s say you buy £1 per point of ABC at an opening price of 3700, but that the price then declines to 3500.
You hope this is just a temporary move, but you decide if the price should fall as far as 3200 it will be time to cut your losses. You place a stop-loss at 3200.
The price actually slides all the way to 2700. However, your stop-loss is triggered at 3200 and your position is closed.
As a result of hitting your stop-loss, you’ve lost £500 (that is, 500 points x £1 per point). However without your stop-loss you would have been looking at a loss of £1000 (the full 1000 point drop x £1 per point).
Guaranteed stop-loss orders
Stops are generally at risk of slippage, which means – if the markets are moving fast or gapping occurs – your bet is at risk of not being placed at the price level you requested. However, some spread betting providers offer guaranteed stop-loss orders which protect you against slippage and market gaps.
A guaranteed stop works in the same way as a standard stop, except that it will always be filled at exactly the level you set. Effectively, your provider takes on the risk of slippage for you. Naturally they require a fee for this additional service, and this normally comes in the form of a wider spread. Generally this charge will come in the form of a wider spread, but some providers will only charge you if your stop is triggered.
Attaching a guaranteed stop puts an absolute limit on your potential loss, and this can be reassuring when you’re trading in volatile markets or in large sizes. However, with those providers that charge a wider spread, the extra cost will reduce any profit you make.
Stop entry orders
A stop entry order opens a bet when a specified price is reached
So far we’ve only looked at stops that can close a position, but you can also use a stop to open a new position – this is known as a stop entry order.
Placing an order to open a bet at a worse level than the current price might appear very odd, but sometimes it can make good sense.
For example, analysis might suggest that if a market hits a certain level it is likely to carry on moving in the same direction. By setting a stop order to open a position at that level, you could potentially take advantage of this momentum.
Let’s say silver is currently trading at $19.00, and has been hovering around this price for a while. Your analysis indicates that $19.50 is a significant level for the metal, so if it passes through this level it will tend to keep going upwards.
You decide you’ll ‘buy’ silver if it reaches $19.80, as this will mean it has clearly broken through the $19.50 level. You therefore set a stop entry order at $19.80.
Your prediction is correct: the price of silver hits $19.80 and continues to rise, earning you a profit on the bet that has automatically been opened for you.
You might argue you could have simply bought immediately at $19 and made a greater profit. However, by using the stop order you waited until the market had given a clear positive signal, giving you more confidence in its potential future direction.
Some providers offer something called a trailing stop, which is a special type of stop-loss that not only caps losses, but also helps protect any profits you make.
Like other stop-losses, a trailing stop is attached to a bet. If the market price moves in your favour by a specified amount (known as a ‘step’), the trailing stop copies this movement. So it keeps its original distance from the current price, but step-by-step it gets closer to the price at which you opened your position, and may pass it if the favourable movement continues.
However, if the market then turns against you, the trailing stop stays where it is. This means it can close your position at a more favourable level than a standard, stationary stop-loss would have done – potentially while you’re still in profit.
Suppose you decide to go short on USD/JPY at 117.60. You set a trailing stop 30 points away, at 117.90. You choose a step size of ten points.
The market initially drops five points. As this is less than the step size, your stop stays at 117.90. The price then drops a further five points to 117.50, triggering your stop to move down to 117.80.
A little later, USD/JPY has sunk to 117.10. Your stop has followed it, and is at 117.40. However, now the market trend reverses and the price rises to 117.50. Your stop remains at 117.40, so your position is closed as the price passes through this level.
The stop has protected a profit of 20 points for you. However, it’s worth noting that if the market’s upward movement turns out to be temporary, you may have missed an opportunity for greater profit by closing the position now.
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