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Take control with automated trading orders

By Nick Sudbury

In the past six months the average intraday movement of the FTSE has been over 100 points, more than double what it was over the previous three years. It is essential that those looking to spread bet in such fast-changing conditions should retain complete control of their open positions. One of the best ways of doing this is to make good use of the full range of available order types.

To consistently take money out of volatile markets requires a disciplined and objective approach. The first step is to devise a plan that covers the entry conditions and all the different possible exit levels. When implemented this should either produce a profit or at worst a controlled loss.

The most difficult aspect of trading is having the discipline to stick to the plan and not let the emotions take over. One of the easiest ways round this is to use orders like stops and limits to implement the entries and exits. These can be left in the market and will automatically trigger the trades if the price hits the specified level.

James Parker, head of spread betting at ODL Securities, says that clients can place orders whenever they want, regardless of whether the market is actually open at the time. ‘What we tend to see is that people rearrange their closing orders in the evening once they have seen where the market has finished. Opening orders typically appear in the morning and are often prompted by pre-market news announcements.’

Opening orders

Those who are looking to open a position at a more favourable level than the current price would use a limit order. This would enable them to buy lower or short higher if the market actually hits the specified entry. Once triggered the limit order would actually be executed at the next available price, with any slippage working in the trader’s favour.

Anyone who wants to open a position at a less favourable level than the current price could do so using a stop order. This may sound counter-intuitive, but it is relevant in a number of situations, including where a technical trader is looking to take advantage of a potential break below support or above resistance.

Parker says that a limit or stop to open allows someone to get in at the desired level without having to sit in front of a screen all the time. ‘Most of the people who leave orders to open tend to be the more experienced traders who have researched the market and identified their entry points. An example would be someone who was planning to go long but expected the price to dip first and wanted to get in at that lower level.’

Closing orders

Once an opening order has been executed it’s possible to attach a new limit and a new stop. These serve to automatically close the position if triggered by the market, with the limit set at a more favourable price to take profits and the stop used to restrict the potential loss. It is also feasible to include these right from the outset by using a contingent or ‘if done’ order to open the initial position. This would ensure that the closing orders would only come into play if the opening trade was actually triggered.

Tom Hougaard, chief market strategist at City Index, says that the main difficulty with trading is that the emotions can take over. ‘Many successful traders get round the problem by using automated entry and exit orders. These allow them to spend less time watching the markets and to place their orders in a calm and composed manner rather than in the heat of the moment.’

The skill in using these types of orders is judging where best to put them. For technical traders this will typically be clear from the chart, but in all cases it’s important to keep in mind the risk/reward ratio. As a general rule of thumb, a new position would only tend to be worthwhile if it could make at least three times more money than it could lose.

‘Limits and stops are very useful when the markets are volatile, as unless people are stuck to their screens they can easily miss the price movements they are waiting for,’ says Parker. ‘The problem is when the orders are set too tight as this can mean getting stopped out early before the market has a chance to move in the right direction, or taking profits prematurely and missing most of the gain.’

The upshot is that, when prices are as volatile as they are at the moment, traders need to allow their positions more room to survive the short-term noise. To avoid the risk of unacceptably high losses this will inevitably mean scaling back the size of the trades.

Slippage

The main risk when using a stop to close a position is that the market can gap straight past it so that the order is executed at an inferior price. This would result in a bigger-than-anticipated loss as the slippage works against the trader, whereas with a limit it goes in the trader’s favour.

James Hughes, market analyst at CMC Markets, says that the main risk of significant slippage is when trading an instrument with a definitive open and close. ‘The danger is that, if important news comes out during the closed period, the price will need to re-evaluate itself when the market reopens. We have seen plenty of instances recently when UK shares have experienced a massive gap on the open, Northern Rock being a prime example.’

The risk of something like this happening on a market that trades round the clock is far lower. This is one reason why the highly liquid currency pairs are so popular among traders.

‘Markets that trade continuously will still gap around, but there will not be the same dramatic shifts as can happen when something reopens,’ says Hughes. ‘Clients who are worried about this always have the option of paying for the insurance of a guaranteed stop.’

Guaranteed stops are available from most spread betting providers, and as the name implies they will always take effect at the specified level, irrespective of whether the market actually trades at that price. Unlike a normal stop there is a cost for this added protection, which is collected by way of a wider spread.

‘It is always a good idea to use guaranteed stops when trading volatile news items such as Northern Rock and Bear Stearns,’ says Hougaard. ‘A normal trending stock that is not in the news is not a suitable candidate for a guaranteed stop, whereas a stock that covers the front page of every newspaper in the UK certainly is.’

Linked orders

The beauty of having a carefully researched plan is that for every open position the trader knows where to take profits and where to cut losses. One way to implement this would be to set both a limit and a stop, but the safer option would be to link them together using a ‘one cancels the other’ order or OCO for short.

OCOs provide complete protection, as once the stop or limit is triggered to close the position the other leg of the order is automatically cancelled,’ says Hughes. ‘These orders are especially valuable in the current volatile conditions, as with a separate stop and limit the risk is that, once one is triggered, to close the position the market could reverse and trip the other into opening a new trade.’

A technical trader might also look to use an OCO to take advantage of a breakout. For example, if a stock was range trading between 100 and 110 the trader could use one leg of the order to buy at 115 to capture a clear break above the resistance, and could then use the other leg to short if the stock broke below its support at 95. Whichever part of the order was hit first would be filled, while the trading platform would automatically cancel the other.

Alex Orban, vice president of E*TRADE Retail in the UK, says that it’s possible to add stop and limit orders to both legs of the OCO and these would automatically be deleted when the associated order is cancelled. ‘OCO orders are very valuable to investors with limited funds who want to take advantage of potential price movements. These types of orders are often used as part of a quick exit strategy, as they save time when people need to move fast.’

Another way to fully automate a trade is by using the parent and contingent orders available from GFT Global Markets. Martin Slaney, the firm’s head of derivatives, says that these allow spread betters to get into the market with market, limit or stop orders. They can then set stop and limit orders to be triggered automatically to try and help reduce losses and maximise profits.

‘Parent and contingent orders allow traders to set up entire trades, including entry, exit and risk management. They don’t have to sit at their desks and watch the market, as the orders are triggered automatically when the pricing conditions are met. It is even possible to set contingent stop orders as either guaranteed stops or trailing stops.’

All these different types of orders can typically either be implemented as good ’til cancelled – although some providers may stipulate a maximum associated time limit – or good ’til close.