Spread Betting Stops
It's often overlooked but choosing the best level for a stop order when making a spread betting trade is a crucial part of being a successful spread better. A stop order should not be seen just as a safety net when things go wrong, but as an important part of your overall strategy.
What is a stop order?
The beauty of spread betting is that it offers the opportunity to make large winnings from small price movements. The downside of this is if the share you are betting on moves a long way in the wrong direction, the losses can quickly mount up. The way to reduce this risk is by using a stop order (sometimes known as a stop loss) to automatically cancel the bet before things get out of hand. When you place a bet you also have the opportunity to set a stop. You then enter the price at which you want the bet to be canceled. If your bet is a buy then the stop has to be lower than the current price. If your order is a sell then the stop must be higher than the current price.
Spread betting stop order strategies
The first question for anyone new to spread betting is: at what price do I set my stop? Here are some of the most popular approaches to this problem:
Percentage stop
The most straightforward stop would be one at a fixed percentage above or below the current price. A typical value would be 10% - 15% but it really should depend on the volatility of the object you're betting on. This method is not very sophisticated and is mainly used by novices. However it does the trick and is certainly better than no stop at all
Support level stop
Take a look at just about any share price chart and you will be able to pick out support levels. These are points at which the price drops but then bounces back as if it has hit an invisible floor. It makes sense to set a stop just below this level because it is quite likely that if the price drops again it will again bounce off this support level. If however the price falls through the support level this is a bad sign in technical analysis and you are probably better off closing the deal anyway. Incidentally we are talking here of regular buy orders. If you are shorting (sell order), you need to look for where the price bounces down as if from an invisible celling. This is called a resistance level. Setting your stop order to the nearest support or resistance level is the method most favored by professional traders because it is simple and very effective.
Trendlines
Sometimes you will look at a chart and a see a price that looks like it's bouncing up steps. It's as if the support level is steadily increasing over time. If you take a ruler and draw a straight line under the dips this is called a 'trendline'. Once a trendline is established it is likely to continue for a while, and it's unlikely to be breached by the price dropping below it. Setting your stop just below this line can be a profitable strategy. What we are talking about here is a dynamic stop that will gradually increase with time. Unfortunately, your spread betting account is not going to let you set this kind of stop so you will have to do it yourself by keeping an eye on the price and stopping the bet manually if it crosses your trendline. If you do this just remember to still continue to set an automatic stop at a price somewhere below the lowest point of your trendline. This is just in case you fall asleep and miss doing it manually. After all - you don't want to wake up broke!
Moving average
A moving average is a line on a chart which is made by averaging the price over a set period (typically 100 days). The resultant line is a slow moving line with all the jagged ups and downs smoothed out. When a currency or share crosses its moving average it is a significant event and taken by traders as a strong sell or buy signal. Moving averages are more suited to long and medium term trades and so are not as reliable for day trading.
The way to set this type of stop is by looking at a chart with a suggested moving average (MA) of 200 days. Set your stop order to the current price of the moving average. There are limitations to this method however. If for example you are making a buy bet and the MA is actually above the current price then you can't do it. Thus in this case you would require the MA to be below the current price. It's also not a good approach if the MA is a long way below the actual price, because you risk large losses. As the bet progresses you may wish to update your stop to the new MA price, but on most occasions it's not worth the effort as the MA moves only slightly over short periods.
Trailing stop
Once you are comfortable with setting stops the next stage is to practice setting a trailing stop. Say you've placed a bet (with a stop of course) on a currency going up and it duly rises. You will then accordingly want to think about increasing the level of the stop so that if the currency does start sinking you will lock in some profit. Typically a trader will keep setting the stop at about 5 - 15% below the current price. In this way, as the price rises the stop level trails 5 to 15% behind.
Guaranteed stop
In spread betting a guaranteed stop loss order is where the broker guarantees to close a bet when the price reaches a certain point. When you set a non-guaranteed stop loss the broker will try their best to close the trade at the specified price, but markets are continually moving and it is normal for the stock to move a tick or two before the stop is actioned. This is called slippage and in most circumstances doesn't make much difference to your profits. Sometimes however there is a risk that the broker for various reasons won't be able to take you out of your position before the price has moved significantly, causing potential big losses. A guaranteed stop loss is designed to protect you from these situations.
A word about risk-reward ratios
One of the most important factors a serious spread better should look at before placing a bet is the risk-reward ratio. The risk is the amount of potential losses one faces; and this is dependent on the stop value. If you bet on a share at £10 per point while it is at £220 and your stop is set to £217, the most you risk losing is 10 x (220-217) = £30. Conversely, the reward is the amount you would expect to win. If you set a limit order where you plan to take profits you can just as easily calculate the potential rewards. A professional would typically be only interested in trades with a 2 /3 risk reward ratio e.g. risking £2 but standing to win £3. When setting your stops be aware of this ratio, and if you find the risk is higher than the reward then perhaps your stop is too cautious, or maybe you simply shouldn't take on the bet.
Improving your stop strategy
Once you have chosen your method of choosing a stop, have made a number of trades using this method and are happy with it, it's a good idea to review your results and see if there is room to improve profitability. The way to do this is as follows:
Each time you place a bet and set a stop, consider what stop you might have set if you were being more cautious; and also what you might set if you were taking a riskier approach. A more cautious stop would be one closer to the current price i.e. less potential losses. A riskier one would be further away.
After about 20-50 bets go back through the charts and work out how your bets would have worked out had you taken the cautious approach. Add up your total earnings (total wins - total losses). You should find that for this scenario the losses on individual bets will be less but there will be more of them. You may also find that winnings are down as potential winners are curtailed with premature stops.
Repeat this process for the senario of riskier stops.
Now compare the 2 totals with your actual earnings.
Hopefully you should find that your actual warnings are larger than the more cautious or risky scenarios. If not then you need to adapt your approach to either pick more cautious or risky stops depending on which totted up as the most profitable.