The Mechanics of Stop Losses and Trailing Stops
What are Stop-Losses?
Due to the volatility of some markets, a stop-loss is recommended for many types of spreadbets. This is a level at which the bet will be automatically closed if the market moves against you. Often these levels may be subject to some 'slippage' if the market moves particularly quickly, and it is not possible for the spread-betting company to close the position in the market. Most companies now offer guaranteed stop-losses, which are guaranteed to close at a certain level. However they usually charge an extra point of two of spread for the priviledge. This effectively transfers sme of the risk of fast-moving markets to the company.
What are Trailing Stops?
A trailing stop is a moving stop that follows the price of an instrument, ensuring that any sudden movement does not wipe out profits already made - effectively locking in profits.
Example:
You think that a rising Oil price will bolster the profits of BP over the coming months, and hence increase the share price.
In July, you place a 'buy' bet on BP.L to end in September (you can cash the bet in at any time up till the end of September). The current share level is 590 pence.
You are offered the following price on BP.L September.
Bid: 595 pence
Sell: 585 Pence
(Generally the further away the end date of the bet, the higher spread is incurred)
You Place a buy bet at £10 a point at 595 pence.
You Place a trailing stop 20 points away from your buy price. (575 pence)
If the price was fall to 575 pence immediately, with the bid/offer at 580/570 your stop would be hit, and you would lose 595-570=25 * £10= £250
However, if the price was to raise to 670 (675/665) pence, you would be in a position to close at 665-595=70 * £10 = £700
If during this time, your trailing stop would have moved to 650 - ensuring that even a fast downward movement would not wipe out all your profits. Even if the market for BP shares crashed overnight, your guaranteed trailing stop would ensure that you profit by 650-595=45 * £10 = £450.
Questions and Answers
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