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Guaranteed Stop Losses

What are they - How they work

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Page Summary:
This page looks at another form of stop, the Guaranteed stop loss. What are they, how do they work, how much do they cost and whether they're more beneficial to the trader than using traditional stop losses.
A guaranteed stop loss is similar to a traditional stop loss but whereas a normal stop might suffer from slippage, a guaranteed stop as its name suggests guarantees a certain exit price.

Slippage is the difference from where a stop loss level is placed and the where the actual order is filled.

For example, if you enter a stop (not guaranteed) to sell £2 of the FTSE at 4300 the actual sell price might be 4297 and the 3 point difference is slippage. More information on slippage on the main Stop Loss page.

Guaranteed Stop Losses
But is slippage that much of a problem, or is it just one of the negatives of trading which every trader, whether large or small, has to accept?

Whatever your view, the Spread Bet brokers offer their clients a way to eliminate slippage once and for all, in the form of what's called a guaranteed stop loss or, as some Spread Betting companies call it, a controlled risk spread bet.

How a guaranteed stop loss works
Think of a guaranteed stop as an insurance policy and of course there is always a price for insurance. For example -
  • You're quoted the FTSE at 4230 - 4232
  • But you're worried about slippage because the market is volatile and so decide to use a guaranteed stop loss
  • However, when you deal, a premium is added to the quote so now the spread becomes 4226 - 4236
  • The 4 points added and subtracted from the original quote of 4230 - 4232 is the insurance cost for the guaranteed stop loss
4 points on the FTSE doesn't sound like a large amount of money but do enough of these trades and unless you're a truly exceptional trader it's going to be extremely hard if not impossible to make money over time.
The downside to guaranteed stops
The insurance is paid upfront
You pay upfront for the cost of the guaranteed stop loss even if it's not needed. For example -
  • You buy £5 of the FTSE at 4232 (+ 4 points of insurance) so your actual dealing price is 4236
  • The market rallies 50 points and you sell out for a juicy profit
  • So the insurance cost of 4 points wasn't needed and theoretically the money has been wasted (with hindsight of course)
  • If you think about this, it's an incredible advantage to the spread betting firm and it's no wonder many of them try to push guaranteed stops so much
Guaranteed Stops can be expensive

In the FTSE the cots if about 2-4 points and with shares anywhere from 0.3% - 0.75% of the size of the deal and believe me those costs, whereas they look relatively small, are a massive handicap to pay.

Don't believe anyone who tells you that guaranteed stop losses are not that much and are worth the cost. Either those people have an interest in selling them or they don't know what they're talking about.

As I have indicated many times on this site, the cost of doing business is an incredibly important factor to pulling profits out of the markets overtime, and it's not all about buying and selling at the right prices, although that helps! So ignore costs at your peril.

Professional traders hardly ever use them

If there's one group of traders who know the important and dominant role that costs play when trading and investing it's the professional traders. So you won't find them using guaranteed stops and that speaks volumes.

The professionals will probably approach the markets like this -

  • They realise that slippage is part of the trading game, but 95% of the time it won't be a problem, perhaps 1-2 points in the FTSE maximum
  • But there will also be countless times where there's no slippage when stops are activated
  • Yes, a few times a year slippage will be a problem but by not using guaranteed stops they will have saved a fortune and it's that money that will be used to pay for the excess slippage
  • In effect they have self insured their stop losses and probably saved a fortune as well
They're designed for beginner traders

Never discount the power of scare marketing, we witness it all the time.

For example, the Vitamin industry regularly uses it - if you don't take your daily vitamins then there's a high chance you'll be in poor health and die early etc. OK, I'm elaborating somewhat but you get the point.

And scare marketing is probably used to push guaranteed stops as well focusing on the fact it's possible to lose more than you expected if some major news/event hits the markets. That may be true but it's not going to happen as much as perhaps they suggest.

When to use a guaranteed stop

Just because they're expensive and bad value doesn't mean we as responsible traders shouldn't use them. I for example would defiantly consider using them in certain situations, such as -

  • If I were to trade an unusually large position - If my trading size in the FTSE is traditionally in the £2 - £7 a point range and I take a position of £30 a point or more that's a lot of risk should the market move quickly against me. So a guaranteed stop loss is worth considering

  • When the markets are exceptionally volatile - Slippage is a way of life for the trader and it's no problem if relatively small. But slippage can be a major problem when the markets are exceptionally volatile, so again I would consider using a guaranteed stop
LearnMoney comment:
Whereas guaranteed stop losses must be welcomed into the trading arena, they offer more flexibility after all, it's my view that they're more about making profits for the spread bet brokers than anything else.

They're often heavily marketed to new traders whereas professionals hardly if ever use them, and that should tell you everything you need to know.

So don't be scared about slippage it's not really a problem unless the markets get super volatile. My advice - just use regular stop losses.

WARNING! - Spread Bet Broker Advice

There are good spread bet brokers and there are bad ones.

Having a good broker won't guarantee you profits but a bad broker will probably lead to losses as a combination of their gamesmanship and suspect software takes its financial toll.

So who do I recommend?

Simple, the 2 brokers I personally use for my own spread betting (and I've used them for years) -

FREE Report : How to Learn Spread Betting and Prosper
How to build the all-important trading experience
Where to get trading help and advice
Which broker to use and why
Simple 2 month training plan to follow
Download the FREE report
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