Stop Start!
On Guaranteed Stops Although stop orders help you theoretically to stop losses, lock-in profits, reduce risk, and possibly free up trading funds, they do none of those things for sure unless they are guaranteed. I’ve had a love / hate relationship with guaranteed stop orders. I’ve loved the fact that they reduce your risk absolutely with no gap-down surprises, and I’ve hated the fact that you have to pay for the guarantees in the form of a wider minimum stop distance plus an account charge or wider spread. While I’ve considered guarantees on stop orders to be non-essential in a well diversified spread bet “portfolio”, in these volatile times I’ve once again grown to love the certainty of the guarantee. Here’s an interesting story: There was once a spread betting platform, now defunct, that boasted “free guaranteed stop orders”. It took me some time to realise that these were not free at all when this particular platform charged overnight financing charges of some 10 times (yes, really) what the other platforms charged for rolling spread bets. The irony is that I actually made more money in this account over a particular six month period than I did in another account that levied much more reasonable rolling charges but which didn’t provide guaranteed stop orders at all. And it was all down to the “whipsaw losses” that I’ll describe shortly.
On Minimum Stop Distances Deciding on the optimal stop distance can be tricky, and accepting the wider-than-usual minimum stop distance of a guaranteed stop can be off-putting. But maybe the spread betting company is doing you a favour with those minimum guaranteed stop distances. When you apply a guaranteed stop order to your position, you are transferring the risk of an unfavourable stop-out (due to slippage or price gaps) to the platform provider. Since the platform provider really doesn’t wish to fall foul of an adverse price move (see next topic), you might conclude that their supercomputer has calculated the minimum stop distance to be the distance at which they do not expect to by stopped-out by the market on a whim.
On Retrospective Guarantees Some spread betting companies oblige you to decide if you need a guaranteed stop order at the time you place your opening trade. Personally, I don’t always know whether I will hold what starts off as a “day trade” during the most dangerous times for adverse stop-outs — overnight or over the weekend — so I don’t always know if I will need (and want to pay for) a guaranteed stop order at all. Did you know that some spread betting platforms allow you to guarantee an existing non-guaranteed stop order retrospectively? I prefer to guarantee my stop orders towards the end of the trading day when I know I’ll be holding the respective positions overnight, at a time when those positions have moved sufficiently into profit during the day... so as to make the minimum stop distance a sensible stop distance.
On Whipsaw Profits I told you earlier how I made money in a spread betting account that mandated guaranteed stop orders on all trades and which made me pay through the nose for the privilege; and it was all thanks to a series of “whipsaw profits”. As the opposite of a whipsaw loss, a whipsaw profit occurs when a volatile price gaps down through your guaranteed stop order — at the spread betting company’s expense, pity them — and you find yourself immediately able to re-purchase at an even lower price (than the stop-out price) before the price bounces right back up. It requires vigilance and quick reactions, but it can be done, and I’ve done it.
Start with Stops I began this article by explaining how stop orders may be just as useful (if not more so) for securing profits as they are for stopping losses. But for most traders, the primary use for stop orders is to exit positions automatically and unemotionally for small losses before those small losses become catastrophic big losses. Setting a stop-out price at the time you open a trade allows you ultimately to exit your position at the level you want to rather than when you absolutely have to (or not at all). Most good traders won’t ever enter a position unless they know the price at which they would exit; consequently they start with stops.
November 2012
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