Using Protective Stop Losses

Using Protective Stop Losses

One of the key characteristics that separate expert spread betters from those newer to the market can be seen in the way each side approaches risk and reward.  New traders tend to get caught up in the prospects of quick riches, and this is easy to do because there are many advertisements for trading systems that promise excessive gains for traders with little or no real world experience.  Expert traders, however, tend to approach these markets from the other direction and focus on the amount of risk exposure that is undertaken at any given time.

Setting Trade Parameters

 To express this view, expert traders set their trades with specific parameters which will outline the maximum amount of money that can be gained or lost at any given time.  Without this, an unstructured trade exposes traders to an unnecessary amount of risk and for those leveraging their spread bets with margin; a situation like this can quickly lead to expensive margin calls or an entirely depleted trading account.  Luckily, there are methods for avoiding this and in the following sections we will look at the various ways spread betting traders can protect themselves from these potentially unfavorable outcomes.

Stop Loss Management

 The first technique that spread betting traders employ involves the use of a stop loss, which is essentially an “emergency break” that will close your trade if market prices move too far in an unpredictable direction.  These trading orders will literally “stop” your losses and protect your account from experiencing further declines.  For the most part, expert traders will employ these orders in all of their trades (usually without exception).

“One thing that must be understood,” said Haris Constantinou, currency analyst at TeleTrade, “is that you must determine the exact price level where these stop losses will be placed before any trades are made.”  To determine this price level, traders will use one of a few different methods.  One option is to use a set a value in terms of price movement, for example $5 in a stock trade or 100 pips in a currency trade.  This is perhaps the easiest method, as it allows for a consistent approach that can clearly defined and can be used regularly.

Stop Losses as a Percentage of Account Size

 But, for some, stop loss parameters like this are too rigid.  In these cases, traders might look to employ a stop order that is based on a percentage of the account size.  So, if a trader is willing to risk 5% of the total account size, $5 will be exposed to risk for every $100 that is deposited into the account.   Many traders, however, will use levels lower than this as it is a general rule of thumb to never have no more than 2% of the account size exposed to risk at any one time.  These numbers can vary, however, as more aggressive traders are willing to take on levels higher than 2%, while more conservative traders prefer to use less than 2% at any one time.