Using Stop Losses

Stop Losses are an invaluable tool in the armoury of the Financial Spread Betting trader. But how do they work and what are the pitfalls?

Most good Spread Betting accounts offer stop-losses, limit orders, trailing stops and take-profit orders, which are triggers that allow you to protect profits you have made, and limit losses in the making.

The principle of Stop Losses is absolutely sound, and allows the investor to set a value at which he or she wants to get out of their position to stop losses getting any worse. But before you laugh in the face of risk, take a closer look at one of the potentially hidden issues with Stop Losses, namely 'slippage'.

There is a misconception amongst some traders that the Stop Loss guarantees the closure of the position and thereby fixes the risk to the trader's pre determined price. In fact, the Stop Loss price only triggers the instruction to sale, and a 'buyer' needs to be found before a position can be sold.

Should the price be falling very quickly, on the back of bad news for example, the price may fall below the Stop Loss price before it can be laid off to another investor. This is termed 'slippage' and, in this event, the loss you face is not limited by your Stop Loss price.

So what should the Financial Spread Betting trader do? Firstly you need to factor the risk of slippage into your overall risk approach. If possible balance your portfolio of Spread Bets between sectors and markets. Secondly, factor the risk of slippage into your mitigation strategy. If capital preservation is the most important thing to you, set your Stop Losses slightly higher than if your focus is income generation. This 'padding' may cost you slightly more in loss making close-outs but will likely preserve capital in the longer term.

Stuart Smith writes widely on Financial Spread Betting Matters and is the owner of information site www.spreadbettingftse.co.uk