As part of planning your trade you need to plan your exit strategy. You need to know the points that you will exit the trade if something goes right, or is something goes wrong.
The stop loss will exit you if something goes wrong. Before we move on to where you should place your stop loss I want to talk about the different types of stop loss systems you can use.
Manual Stop Losses
Firstly you have the manual stop loss. This is where you know your exit point and when it reaches that point you log into your financial spread betting account and initiate the exit.
I don’t like this method. Whilst it may prevent some of your trades being stopped out from random noise i.e. by the time you go to trade the price is back to normal levels, I think its disadvantages outweigh that advantage.
To start with you need to extremely disciplined. A new trade may say he or she will adhere to the stop loss beforehand but when it comes to pulling the trigger it is often easier to see a paper loss than an actual loss. A paper loss gives someone (false?) hope of a recovery. An actual loss is money gone.
Secondly, you have to be quick. Price movements can move against you very quickly. You have to be ready and you have to be prepared. What if your internet connection is down or there is something else that prevents you from exiting the trade? You are fully exposed by using manual stop losses.
Automatic Stop Losses
One thing I would expect from my financial spread betting company is the ability to trade with automatic stop losses. You set the price you wish to exit the trade and once the price reaches that level your trade is triggered.
It is important that you understand the price your stop loss will be triggered at. Will it be at the mid price, the market spread of the firms spread? You need to check this with your financial spread betting firm.
The advantages of automation mean that you don’t have to rely on yourself pulling the trigger. It is taken out of your (reluctant) hands. It is quick, relatively painless and you can then move onto the next trade.
It is important to note that just because you tell your financial spread betting company to exit at a certain price it doesn’t necessarily mean that you will definitely get that price.
Sometimes prices move so quickly that your price is missed and you get the best price that you can. To take an extreme example…
Say your stock loss on XYZ PLC was 2% below the current price level. If the company released a profit warning over night and the price in the morning opened 20% below the previous close, your trade will be exited at the opening price.
And that moves us on nicely to guaranteed stop losses.
Guaranteed Stop Losses
We saw that with automated stop losses that although the trade will be triggered automatically, you don’t necessarily get the price you wanted. With guaranteed stop losses, as the name suggests you do!
So why doesn’t everyone use guaranteed stop losses then? Well, they come at a price. Some firms don’t even off them at all but for those that do they often they charge for them. This is because they are saddled with more risk.
As financial spread betting becomes more and more competitive I can see the price of guaranteed stop losses coming down. This will be a good thing for us.
Which type of stop you go for depends on you trading style and your own preferences. Whether you go for a guaranteed stop or automatic you have the weigh up the advantages of the guaranteed stop loss against the extra cost.
At the very least you should have an automatic stop on each trade.
In the next post I will be looking at where to place your stop loss when formulating your financial spread betting strategies.