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What are stop loss orders?

Posted By Robert On Sunday, September 7th, 2014 With 0 Comments

What is a Stop Order? A stop order is an instruction to place a trade at a less favourable price than the current price. If you are buying this means that you put on an instruction to buy at a higher price than the current price. If you are selling this means that you put on an instruction to sell at a lower price than the current price.

A stop loss is as such an order that you can add to a trade which enables you to limit your risk. This means that you can decide before placing a trade how much you’re willing to risk and feel safe in the knowledge that any losses incurred on a position will not exceed your specified risk exposure level (allowing for slippage). The added benefit of stop losses is that you do not have to constantly monitor your positions as the stop loss will fill automatically. E.g. if you choose to buy (go long) for £1 on Ryanair at £3.60 a share but you wish to limit your risk to approximately €100 (allowing for slippage), you would place your stop loss level at £2.60 which on the provider’s platform would be a level of 260.

Please note: While brokers endeavour to fill all orders at requested stop levels, stops may be subject to slippage or gaps, in which case the order will be filled at the next available price.

Stop losses can be used to protect against adverse scenarios. In reality there are three types of stop loss orders. A normal stop loss order is free and instructs the spread betting or CFD provider to close a trade at a pre-determined price. For instance, a trader who buys into the FTSE 100 index at 6420 for £5 a point, in the expectation that the index will rise, could also, say, place a stop loss order at 6390 to protect against a decline in the index. So if the index falls and hits your stop loss, your losses would be limited to £150.

Most providers now have a minimum trade size starting from £1 per point, so you don’t need to take massive exposure either. To take this into perspective, a 1p move in a stock price is equivalent to a one-point view in spread betting terms. So if someone believed that Astrazeneca’s stock price would continue on its uphill climb, a 10% stop loss based on the present price (3260p at the time of writing) would be 326 points away. At £1 per point, this represents a risk of £326, so it should be feasible to limit risk while freeing up money for taking on extra opportunities.

A ‘normal’ or ‘standard’ stop loss order is better than having no stop loss order but the trigger level is not guaranteed. If the next day the market gaps through your stop loss, the provider will close your trade at the best possible price. A market gap can happen when there is an unexpected market announcement that sends the share price sharply higher in one direction with no trading in between.

Guaranteed stop orders solve this issue as they ‘guarantee’ the price at which you exit a trade. Let’s suppose you buy shares in a company at 380p for £5 a point ahead of the corporate trading update. You are worried that the stock price could be very volatile so link this trade to a guaranteed stop at 360.50p.

The company announces a trading update that is worse than expected and its stock price gaps first thing next morning, with shares falling to 350p. But since you had a guaranteed stop loss order in place your trade is stopped at 360.50p even though the shares never traded at this price, limiting the loss at £97.5

Note that a guaranteed stop loss order is not free and your provider will charge an extra fee for it.  Only dealing desks offer guaranteed stops, as guaranteed stops are not a natural part of the market. Firms that guarantee stops do not send client orders to the open market but instead internalise (bucket) the orders.

There are also trailing stop loss orders which are a way to lock-in profits in trades. For instance, a trader who buys shares for £5 a point at 660p and links this to a trailing stop 20 points lower at 640p with a step of 10 points. During the next few days the shares move higher to 690p. The trailing stop loss order adjusts to 670p leaving the 20 point distance intact.   A few weeks later the shares drop – your stop loss is activated at 670p, protecting your profits of £50.

Summary of Trading Orders

Stop loss order: the trade will be closed automatically if the market moves against you by the amount you specify when you make the order, limiting your losses.

Trailing stop loss order: similar to a ‘Stop loss order’ but the trigger level for a ‘Trailing stop loss’ rises with the underlying asset price. So instead of allowing the asset price to plummet before the Stop loss order is activated, the position will be closed to lock in any profit at a set level below the asset price.

Take profit order: closes the trade automatically if the market moves in your favour by the amount you specify.

Limit order: A limit order is an instruction to place a trade at a more favourable price than the current price. If you are buying (going long) this means that you put on an instruction to buy at a lower price than the current price. If you are selling (going short) this means that you put on an instruction to sell at a higher price than the current price. A limit is an order that will execute a buy (sell) trade at a set price which is below (above) the current market price.

Market-if-Touched order: This is an order that will execute a buy (sell) trade at a set price which is above (below) the current market price.

Providers will execute your order at or as close to the specified price as possible. In a rapidly changing market, the provider’s price quoted to you at the time of the order (or in the case of a Limit Order, Market-if-Touched Order, Stop Loss Price or Take Profit, the trigger price) may not be the same as the providers’ price at which the order is actually executed or triggered.

When does my order expire?

On the order ticket, you have an option to choose when your order is ‘Good Until’. The option box will give you two choices.

Good until ‘Cancelled’
This means that your order will remain open until you manually cancel it or the associated contract expires.

Good until ‘End of day’
This means that your order will expire at the end of that day, i.e. at midnight that night.

Custom Expiry Date & Time
You can also choose a preferred date and time for your order to expiry.

Will Stop Loss or Limit Orders be triggered at the specified price?

The platform will execute your order at or as close to the specified price as possible. In a rapidly changing market, the provider’s price quoted to you at the time the order (or in the case of a Limit Order, Market-if-Touched Order, Stop Loss Price or Take Profit Price, the trigger price) may not be the same as the provider’s price at which the order is actually executed or triggered.

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