There are only two rules in financial spread betting . Rule 1 is “preserve you trading capital at all costs”, and Rule 2 is never forget rule One! Like most things in life, trading is very simple – get the simple things right and you will make money. Risk management is very simple, but very few traders implement it, preferring to trade on hope and expectation, rather than on facts. The facts are simple – lose your trading capital and you are out of the game.
If you ever receive a margin call, then you are out of control and clearly have no risk management in place, and your broker will take you out of the market, which is the best place for you in my view. Nobody likes losing money, but in trading it is a fact of life – to have winning trades, you also have to have losing trades, but your losses are kept to a minimum and cut short using simple risk management tools. Below are the most popular, how they work, and how to use them.
Repeat after me – “I will never open a trade without a stop loss in place” – if you follow this rule it will make you more money in your trading than anything else you ever do in your trading career – why? – because it will preserve your trading capital and keep you in the game. So what is a stop loss, what types are available and how do they work. Well, a stop loss is exactly that – it stops further losses, and will close out your position and prevent further losses in the position. In financial spread betting it is vital that you always use them for all the reasons I have explained. There are several different types available so let’s look at how they work and the advantages and disadvantages of each type.
Simple Stop Loss
Let’s go back to our December Tesco Futures example where we opened our position based on a spread of 318 – 321, and went long at 321 at £1 per unit. We decide that we only want to risk a maximum of £30 should the trade go against us, so we enter a stop loss order with our spread betting company at 291, which goes below our opening price ( if we were short then the stop loss goes above!) So in the event of the Tesco share price falling, to 270 on poor results, our stop loss would be triggered and become a sell order to close out our position at 291, and keep our losses to £30 ( 321 – 291 * £1). The problem with this sort of stop loss is that it is NOT guaranteed. If the share price gaps down overnight for example, or markets become very volatile and fast moving, then the spread betting company will not guarantee to close at this price – they will do their best to get you out of the market as quickly as possible, but there is no guarantee. Now generally a simple stop loss is free, if you want a guaranteed stop loss then this will cost.
Guaranteed Stop Loss
In the above example if we want to be guaranteed that our position will be closed at 291, then we must use a guaranteed stop loss. Generally the spread betting company will quote a slightly wider spread which will include the cost of the stop loss. Whatever happens, even if the market gaps through your stop loss level, you will be guaranteed the position will be closed. Please bear in mind that this order type is not available in every market, so please check with your financial spread betting company.
Now the third type of order is a limit order, which is often used in tandem with a stop loss order, to define the profit and loss profile on a position. So in the above example you may decide to place a guaranteed stop loss order at 291, and a sell limit order at 391 – this would give us a maximum loss of £30, and a maximum profit of £70. Limit orders to buy are placed below the current market price, and limit orders to sell are placed above the current market price. Again there is a cost, and they are generally used where you may be away from your screen but want to ensure the position is closed out, should the price target be reached. This will happen automatically and is guaranteed.
Now, when you look at the market information sheets for a particular spread betting company, you may see a column headed Max CGSL, and wonder what this is? – this simply stands for computer generated stop loss. Many spread betting companies now automatically add a stop loss to your position as soon as it is opened, and this simply tells you the maximum level at which this will be generated, and for each trade will generally be based at around 80% of the funds available in your account. This is normally free, and will happen automatically, but you do of course have the option of changing the level at which it is set and also whether it happens automatically or not – for new traders I would strongly recommend that you leave this on automatic when you start.