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Guaranteed stop
Published: 04/26/2018

 

Summary: Similar to a guaranteed order, this is a bet where a spread betting provider will guarantee you will exit a position once a certain price level is reached. This cuts out the risks associated with volatility but there may be a small charge applied to the bet to put a stop order on a bet.

 

By definition, most profit opportunities in the markets carry a certain amount of risk. When trading, the only tool that we have real control over is risk management. We can control our risk, but not future price movements.

To keep losses low and grow their capital, traders should use stop-loss orders in all trades. However, did you know that a regular stop-loss order isn’t able to protect in you during all market conditions, such as when breaking news hit the market, volatility suddenly increases, and markets open with a gap

Let us introduce guaranteed stop-loss orders – orders that will always close a losing position at your pre-specified level – guaranteed.

 

Brief Intro to Stop-Loss Orders

Stop-loss orders are designed to limit a trader’s losses when the market goes against him. In a long position, a stop-loss order would simply sell the underlying security when the price reaches the predetermined price to the downside. 

 

For example
A trader could be long stock XY at $50 and put a stop-loss order at $45 to limit his losses to $5 per share. If the trade shows to be a loser and the price drops to $45, the stop-loss order would avoid larger losses by selling the entire position. 

 

Stop-loss orders can also be used in short positions, only that in this case the order would buy the underlying security once the price reaches the pre-specified price level. 

Stop-loss orders are extremely useful in risk management. Not only do they limit one’s losses, but they also help in controlling emotions and managing trades when a trader is not in front of a trading platform. 

The level at which you want to place your stop-loss order depends completely on your trading style, money management, and risk tolerance. Short-term traders may use tight stop-losses, while long-term traders would be better off by using wider stops. 

Stop-loss orders become market orders once the price reaches the stop-loss level

Price fluctuations caused by market noise can trigger a stop-loss order only for the price to immediately reverse in the direction of your trade. To avoid stop-losses to get triggered by regular market noise, try to identify the average volatility of the instrument you’re trading and place your stop-loss at a level slightly wider than that. Important market reports and unexpected events may also cause large spikes in the price and trigger a cluster of stop-loss levels, only to see the price return to its previous level.

Stop-loss orders become market orders once the price reaches the stop-loss level. In a long position, a stop-loss becomes a regular sell market order, and in a short position, it becomes a regular buy market order. 

While this concept works quite well most of the time, there are times when a regular stop-loss will get triggered at an unfavourable price level, such as during times of high market volatility. When bid/ask spreads widen significantly, your total loss can be much higher as there aren’t enough buyers or sellers to take the opposite side of the stop-loss order.

Fortunately, there is an effective way to keep your losses at your desired level. Guaranteed stop-loss orders help you achieve exactly that.

 

Read:

15 Must Know Forex Trading Terminology

The Best Futures Strategies to Use (And Ones to Avoid)

Super Duper Swing Trading Strategies

 

 

What is a Guaranteed Stop Loss Order?

A guaranteed stop loss order is a type of stop loss order that gets executed exactly at the pre-defined price level, regardless of volatility and slippage. They work in the same way as regular stop-loss orders, but your exit point is guaranteed when using GSLOs. 

A regular stop-loss order is an order that sells the underlying instrument at a pre-specified price level when you’re long and buys the underlying instrument when you’re short. They’re used to manage your risk and control your losses. 

However, in times of large market volatility and increased slippage, such as around the release of important market reports, the bid/ask spread of your traded instrument can widen significantly and trigger a regular stop-loss order at an unfavourable level. 

Let’s say you go long EUR/USD at 1.1520/22, which means that you’re buying euros for $1.1522 (the ask price.) A stop-loss order that is placed at 1.1510, for example, won’t get triggered until the bid price (price at which buyers want to buy an instrument) hits the stop-loss level. This means that stop-loss orders use different prices to close a position – they buy in short positions and sell in long positions. 

 

Spreads and Slippage

While regular stop-loss orders work just fine most of the time, unexpected market conditions can widen the bid/ask spread significantly and trigger your stop-loss at a very unfavourable price level. To avoid this risk, traders can use guaranteed stop-loss orders that will close your position and limit losses exactly at your pre-defined price level, regardless of underlying market conditions.

Most brokers require a so-called “GSLO Premium” to use guaranteed stops. Since the market and directional risks increase for the broker when traders use guaranteed stop-losses, the GSLO Premium helps cover a part of that risk. Some brokers that offer guaranteed stops will charge you for using them only if your stop gets triggered.

 

The GSLO premium is calculated by multiplying the GSLO Premium Rate with the number of traded units (position size). GSLO Premium = GSLO Premium Rate x Position Size.

 

Market Gaps

Guaranteed stop-loss orders work especially well when markets are gapping (or jumping). Imagine a market-moving event that happened after the market has already closed, such as a natural disaster or a sudden rate cut. Markets will often open with a significant gap to the upside or downside as traders and investors are looking for a new equilibrium level to discount the new event. 

A gap is simply a difference in price between the last closing price and the new opening price. It’s not unusual for the stock or FX market to open with gaps after the weekend when fresh news gets discounted Monday with the market open. Guaranteed stops can help limit your losses during those times.

 

Example of Guaranteed Stop Loss Orders

Let’s say you want to go long EUR/USD at a price of 1.1550/52 with a position size of 1 lot. You’re buying 100,000 euros at a price of $1.1552 and want to hold the position open over the weekend. 

However, since you’re concerned that unexpected market developments may cause the EUR/USD pair to open with a gap on Monday, you decide to use a Guaranteed stop-loss at 1.1530 instead of a regular stop-loss order to limit potential losses. Remember, a guaranteed stop-loss will close your position exactly at the pre-specified price, regardless of slippage or volatility.

The ECB announces an unexpected change to its monetary policy over the weekend which sends the EUR/USD pair lower 100 pips with the opening of the Monday trading session. A regular stop-loss order would close your position at the new bid price, but your guaranteed stop closed your long at the pre-specified level and prevented higher losses.

Your total loss with a regular stop-loss would be around $1,000 (100 pips x $10/pip). The guaranteed stop-loss limited your losses to $200 (20 pips x $10/pip).

 

Pros and Cons of Guaranteed Stop-Loss Orders:

Pros:

  • Guaranteed stop-losses limit your losses in times of high market volatility
  • They can be used to design an effective risk management plan
  • Guaranteed stop-losses preserve your capital, even when markets are gapping

Cons:

  • Brokers usually charge a small fee for using guaranteed stop-losses
  • In the majority of times, normal market conditions don’t require a guaranteed stop-loss
  • If you’re trading with little or no leverage, you may not need guaranteed stop-losses

 

Final Words

Guaranteed stop-loss orders are an effective tool to keep your losses and risk under control in times of high market volatility. Unlike regular stop-loss orders, whose execution depends on the current bid/ask spread, guaranteed stops will always close your trade at the pre-specified price level, so you can keep on trading without worrying about future market conditions and slippage. 

For a small fee, you can use guaranteed stops in all of your trades and get a guaranteed exit if the market turns against you. Whether you should use them or not depends on your personal risk tolerance, risk management, and trading strategy.

 
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