Stop Losses can also be used when financial spread betting as well as investing to reduce the risk and your potential loss from a bad trade.
A stop loss simply refers to a level that you set in order to close a trade at, with the idea being that you prevent your losses spiraling out control if your bet is going the opposite way.
An example of applying a stop loss to a financial spread bet
Let’s say you like to trade the FTSE 100 index. You expect that that the Bank of England is set to announce the cutting of interest rates imminently to help the economy recover from a downturn.
You have a quote for the FTSE 100 index equivalent from your financial spread betting company. It’s 4995 at 5000 (bid-offer).
As you are expecting to increase, you buy £10 a point at 5000.
You also put a stop loss at 100 points below, as you are not sure that the interest rate cut will be big enough.
If the index moves against you, your full loss without the stop-loss could be £50,000 – on the very unlikely situation the FTSE 100 equivalent falls to 0.
But as you put a stop loss in place at 50 points below, your loss will be limited to £500 (50 points at £10). So even if the FTSE 100 spirals out of control, your loss will be stopped at the 50 points rather than the full 5000!
Even if your stop-loss doesn’t come into play, you will need to inform your provider that you want to close out your buy trade (and sell) or cancel the stop-loss! Some companies do this automatically when a trade is closed, although some don’t.
Types of stop losses – key to protecting losses as well as profits
There are also different types of stop losses to be aware of:
- Guaranteed stop loss – usually with a bigger spread in the quote (bid-offer).
- Non-guaranteed stop loss – usually good enough for most but no guarantee your loss will be stopped at the exact level you want.
- Trailing stop-loss – this allows you to lock-in your profits by raising your stop loss to a higher point. In an example, you may have had a long position and it’s correct, but you expect your bet to fall from a peak and want to limit the downside risk. So let’s say you had an open position at 100 on Tesco and stop loss at 80, Tesco rises to 150 but you then up your stop loss to 130p so that you can lock in your gain. Tesco eventually settles at 110p but you wisely took your profit at 130p!