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Stop Losses

They have a hidden and powerful value

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Page Summary:
There's more to stop losses than working out where to take a hit should the market move against you. This page explains how they can be used to trade the perfectly sized trading position.

Stop losses not only protect your trades, they have other benefits in helping you to trade the perfect sized position.

For example, why do so many spread betters always trade a similar size? Perhaps £4 a point of the FTSE or £20 of Vodafone etc?

The hidden value of Stop Losses
Or maybe they are never sure how much to trade always fumbling and guessing. But if you know where your stop loss is, you can easily determine the perfect size position as this page explains.

Successful trading is all about respecting the potential risks

One of the main mistakes many new traders make is that they think it's all about the profits. For example -

  • Take 2 traders and give them £5,000 each then let them loose on the markets for a year
  • One trader makes 150%, the other just 20%
  • So who's the best? Most people will point to the trader who made 150% because it's all about the money, right?
  • Wrong - it's all about how much was risked to make a given return
  • The 150% man might have risked 10% of his account balance on each trade which means the chances of him going broke at some stage in the future is almost guaranteed
  • But the trader who made just 20% only ever risked 1% of his account per trade so from a risk-based perspective this guy was far better than the 150% one
The Casino v Trading - Both have advantages and disadvantages - Try to combine the positives
The main advantage a Casino has over trading the markets is your loss is fixed.

The disadvantage is the profit is also fixed (Poker excluded). Bet £10 on Roulette's number 35 and your maximum loss is £10 with a maximum profit of £350.

The disadvantage to trading, spread betting included, is your potential loss is properly known beforehand and can in some circumstances be unlimited (short the FTSE at 5,000 and it could theoretically rise to 25,000+ before you throw in the towel). Note that I'm talking mainly theory here so I don't want to scare anyone and give the impression that losses can't be controlled.

So why not try to combine the advantage of a Casino -

  • A fixed loss
  • With the advantage the markets offer - open-ended profits

And the way to achieve this goal is to use stop losses. The added advantage to this is you'll always know exactly how much to trade per position so guesswork will never be an issue.

How to determine the perfectly sized trading position
First decide how much of your trading capital you are willing to risk on each position. Let's assume the sum is £100 and see how it plays out with the 2 examples below.

Bullish on the FTSE

  • You're forecasting the FTSE higher over the next few days, the current quote is 4220-4222
  • According to your charts/analysis there's an important support level at 4190 and so 4185 looks a sensible place for your stop loss
  • If you go long at 4222 the difference to the stop loss level of 4185 is 37 points
  • £100 / 37 points = £2.70 per point
  • The market does indeed rise and you sell out for a 100 point profit
  • Profit = 100 points x £2.70 = £270
Now assume a similar trade but this time the stop loss level is a lot closer to where the FTSE is currently trading -
  • The FTSE is 4220-4222
  • Your charts/analysis suggests good support at 4210 and so place your stop at 4205 for a risk of 17 points
  • £100 / 17 points = £5.88 per point
  • You therefore go long £5.88 of the FTSE at 4222
  • The market does indeed rise and you sell out for a profit of 100 points
  • Profit = 100 points x £5.88 = £588

Now concentrate - if the trade hadn't worked the loss would have been £100 + any slippage

Can you see what's gone on in the above two examples? In both trades the risk was the same, £100 with the difference between the entry price and the stop loss level used to determine the exact sized position to take.

So when a wide stop is used a small trading position is taken. Conversely, when a tight stop is used a much larger position can be taken.

To the uninitiated, the people who wrongly assume this game is all about profits, they would think with the examples above that the 2 trades had different risks attached. But clearly this is not the case.

Using this type of betting size strategy is therefore a major advantage to the switched on spread bet trader, the trader who recognises that it's never about how much you make but always about how much was risked to make a certain profit.

Professional traders are the masters of this kind of trade allocation and it is the main reason the size of their trading positions can vary tremendously. As an added bonus you will also find that in times of high price volatility your positions are naturally reduced. In effect you are adapting to how the market is trading and that's only common sense.

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
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