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A Guide to Stop Loss Orders

Stop losses are market orders designed to allow you to limit your losses.

When you place a stop loss you are instructing the spread betting company to cut your position when it reaches a certain loss level (or in some cases, profit level - more later).

Therefore, a stop loss will automatically close your trade if the market reaches a certain point.

For example: You have bought £1 a point of the German DAX at 4200. The most you are willing to risk is £150 on this trade so you place your stop at 4050.

If the market trades at 4050 you are taken out immediately and you lose £150.

Normal Stop Losses

These are free but with this type of stop you can sometimes lose more than you specified when you placed the order.

Sometimes your stop loss order may not be filled at the level you wanted i.e. you may be taken out at 4046 instead of 4050.

The bookmaker will attempt to get you out of the trade at the price you specify but when the market is moving very quickly it may not be possible.

This is called "slippage" and tends to happen in a fast moving market.

You can also lose more than you wished if the market you are trading "gaps".

For example: You have opened a long trade on the Dow Jones for £1 a point at 10000. As you were willing to risk £200, you placed a stop at 9800.

Over the next couple of days, the Dow moves down slightly to 9900 and at the end of trading on the third day it is sat at 9890.

The next day some very disappointing economic figures are released and the Dow opens well down at 9700. As this is past your stop loss, the bookmaker closes your bet at market price.

Your trade is closed at 9690, 110 points below your stop loss so your loss is now £310 rather than the £200 you were willing to lose.

You can ensure you are closed out at the exact price you specify by using a Controlled Risk or Guaranteed stop loss order

Guaranteed Stop Losses

These types of stops are designed as a type of insurance to guarantee that your stop loss order is filled at the exact price you specify.

Even if the market you are trading gaps 1000 points beyond your stop, if you are using a guaranteed stop loss you will still only lose what you have already decided is an acceptable loss.

You pay a little extra for a guaranteed stop. In the Dow example above, a guaranteed stop would cost roughly 4 times the stake (4 x £1 = £4). Usually the premium is taken from your account balance when setting the stop loss level or is added to the spread.

Although they do reduce your account balance, guaranteed stops can save you a great deal of money and are certainly recommended if you have a small capital base.

Some Pointers About Stop Losses

- Never move your stop if you think it may be hit. If you move the stop further down to try and avoid being taken out you will simply lose more money.

- You don't have to close your entire position with a stop loss order. If you wish, you can set up 2 or more stops. For a £1 per point trade you could set a stop 100 points away which reduces you exposure by 50p a point. Another could be placed 200 points away to take you completely out of the trade.

- It is better to let the stop take you out of the market and preserve the rest of your capital than to try and stay in the trade by moving the stop.

- You can lock in profits by using a stop loss. If you were to enter a long trade on the Dow at 10000 with a stop at 9900 and the Dow moves up to 10200 you could then move your stop to 10100 to lock in 100 points profit.

- Never trade without a stop loss, even if it is just a normal stop. To stay in the trading game you must preserve your capital and huge unexpected losses will certainly not help. See the Money Management section for more details.

Explanation of the Different Types of Market Orders

A stop loss order (order to close open positions in order to prevent further loss) is only one type of order which can be used when spread trading.

There are several other types of order which can be summed up as follows:

Limit Orders

A limit order is used when you would like to buy or sell at a price which is better than where the market is currently trading.

For example: The French CAC is trading at 4000 but you think it will rise slightly before falling. In this case you could leave a limit order to sell at a higher price such as 4100. This order would now be "on limit" and should 4100 be touched, a new short position would be automatically opened.

You can specify how long you would like the order to be open for:

Good Until Cancelled (GTC): This order will be open until it is cancelled or the contract reaches the expiry date (when the order will be deleted)

Good For Today (GFD): This type of order will remain in place until the end of the trading day unless cancelled by you before then.

Good Until Time (GTT): Order is valid until a specific date and time unless it is cancelled before then.

Limit orders can also be used to close your position so that you can take your profits at a specified level.

Contingent or "If Done" Orders

This type of order is used to attach a stop or limit order to a position but only if the original order is filled.

For example: You set an order to buy the Dow at 10500. In order to automatically add a stop loss to this position if it is filled, you add a Contingent order to attach a stop at 10300. The stop loss order will only be added to your account if the Dow Jones position is triggered.

This type of order allows you to protect positions which are opened automatically by the bookmaker.

One Cancels the Other (OCO) Orders

This type of order is used if you have two opening orders setup on the same market. If one order is triggered, the other is automatically cancelled.

For example: The Swiss SMI has been trading in a range of 6100 to 6300 but you think that there will be a major move one way or the other. You place two limit orders; one to sell at 6050 and one to buy at 6350. If one order is triggered and a position opened, the other is cancelled.

This type of order can also be used with open positions. If you setup a limit order to take profit and a stop loss to close your position, when one is hit the other is automatically deleted.

Partial Closing Orders

As already discussed in the stop loss part of this guide, orders can be placed to "part close" a position when a specific market level is reached.

This kind of order could be attached to part close your position when you have reached a certain profit goal leaving only half your position open. By using this order you have already locked in a certain amount of profit but your trade is still open with a smaller stake.