Financial Spread Betting - Stop Losses

We all know that Financial Spread Betting carries with it a number of risks. The potential for significant upside is matched by an equal and opposite downside. So the successful user of Financial Spread Betting will have an effective method for managing the down side and running with the upside. In this way, he will be able to both maximise his overall returns whilst at the same time putting in some mitigation against large one-off losses.

The main tool used by successful traders is the 'stop-loss'. This is simply using the platform provided by the spread betting provider to implement an 'if, then' order. But how might this work in practice?

Let us take an individual with a bank of £3,000 who believes that the share price in Company X will rise above its current value of 100. It is currently being quoted at 99-101, and he wants to bet £10 per point, so he places a buy order at 101. Now, hopefully our clever investor has called this correctly, and he goes on to take his profit as the share price rises. But what if it goes the other way? There are two problems here. Firstly, he may not be able to watch the market 100% of the time. The share price could fall in his absence, and he could come back to it to see a large loss. The second issue is knowing exactly when to sell on a downward trend. In the cold light of day he may have a clear strategy that he doesn't want to lose more than - say - 3% of his bank on any one trade, but in the heat of a moving share price, logic may not always apply.

The answer is to incorporate a stop-loss policy for each and every trade into your trading strategy; one that matches your own risk appetite. So in this instance, our trader doesn't want to lose more that 3% on any one trade. So 3% of his £3,000 bank is £90, or 9 points at £10 per point. Clearly, then he needs to set a 'stop-loss' sell out at 92p (101 purchase less 9). Once that mechanism is in place, if the sell price moves down to 92p a trigger closes the trade, and the loss is controlled within our trader's risk appetite.

Be aware, though, that ordinary 'stop-loss' tools only trigger the sell out once the pre-determined price is reached. What does this mean? Well, in a rapidly moving market it is possible that between the time the price to sell is triggered and the actual sale is executed, the market may have fallen even further. This is called market slippage. Indeed, should the share be suspended, there is still a possibility of a zero price sale, even with a 'stop-loss' in place. It is possible to buy a 'guaranteed stop-loss' from some providers, where the spread betting firm itself guarantees a sale price and takes the risk of market slippage on itself. Of course, in return for this the price - or margin - on the stop loss is greater, so you need to evaluate this possibility yourself based on your own risk appetite.

In my next article we will look at other ways we use 'stop-losses' to maximise returns, including the use of 'trailing stop losses'.

S Smith writes extensively on Financial Spread Betting and recommendshttp://www.financialspreadbetting.co.uk as the site of choice for trading in Financial Spread Bets.