With any means for achieving financial gains, there is also a risk of loss and when trading the asset markets, there can be make these substantial losses difficult to manage. But one advantage of Spread Betting is that it allows prudent traders to limit these losses, through controlled, pre-planned position levels called stop losses. These stop loss levels can be set in terms of either account percentages, dollar values or technical analysis levels and can keep traders from losing money when price activity moves in an unfavorable direction.
At this stage, most of the online trading brokerages allow traders to put automatic stop losses in place and they will even guarantee execution in volatile trading environments. It should be remembered, however, that these automatic stop losses can (and should) be adjusted to meet your individual needs and trading styles and not used in a purely robotic fashion determined by the default settings in your trading platform.
Next, we will look at an example of when using stop losses can protect traders from dangerous market environments. Think back to the credit crisis that hit US stock markets in late 2008. For most traders, the drastic moves that were seen were surprising. In some cases, the massive declines that were seen in a majority of the commonly traded stocks resulted in substantial losses for many traders with long positions.
The FTSE 100 and the Dow Jones Industrials quickly erased all of its yearly gains and the value of many stocks plummeted to nearly zero. Now, if you had been invested in any of these stocks without a stop loss, the unexpected moves could potentially have cost your entire trading account. This is even truer when margin leverage is involved and trading sizes are magnified.
While it is true that stop losses would not have prevented losses from occurring, this case provides us a classic example of how the use of a stop loss would have made this market volatility much more manageable. Many new and inexperienced traders are concerned about this potential “nightmare scenario” but the fact is that any trader who used protective stop losses would have been able to control unprofitable trades and close them before the loss became excessive.
One of the biggest problems, however, when using stop losses is the placement level. Any experienced trader can tell you multiple stories about having a trade work in an unfavorable direction, only to have the trade stopped out at a loss and then see prices reverse later into levels that would have been profitable had the trade not been closed. The reality is that will happen from time to time because it is impossible to predict exact reversal points in every trade. The key to remember is that stop losses should protect profits more often than they create losses, and as long as this balance is maintained, traders can remain successful over their longer term career.
One final point is that not all brokers have the same terms of agreement and stop companies have stronger guarantees when filling stop loss orders than others do. During major news events or times of low liquidity markets have the potential to gap and overrun your stop order completely. This can mean (in some cases) that your stop loss order is not filled and the trading losses can continue to accumulate. Because of this traders should ask what types of guarantees are offered before placing trades with your broker.