When is a stop loss not a stop loss? Trawl through the small print of any sharedealing, contracts for difference (CFD) or spread betting account and you will notice the provider will not guarantee to execute your trade at the desired level. It will try to do so, but if prices are moving so fast, or ‘gap’, even with the best intentions there is little it can do.
There is, however, a belt-and-braces approach to stops – namely the guaranteed stop loss (GSL). While these are not available on ordinary equity dealing accounts, almost all the spread betting and CFD providers provide them. In fact if you are taking out a basic derivatives account chances are you will find the broker insists you take out a GSL.
Given the potential monetary downside when leverage is involved missed stop losses take on more significance, so it is perhaps understandable why a trader would want a guarantee in today’s volatile markets. But there is an argument that says the cost of a GSL does not match the rewards as there is only ever a slim change of a normal stop failing to work.
Battle lines drawn
On one side of the fence is Simon Denham, managing director of Capital Spreads, who likens GSLs to an unnecessary insurance policy. On the other side lie the companies with clients who will happily take up to a 1% fee on the most volatile stocks in exchange for a cast-iron guarantee the make up the difference if unable to execute at the desired price.
Denham – whose spread betting service does not have a GSL option – claims regular stops work ‘more than 99%’ of the time for his clients. Guaranteed stops, however, are voluntarily used by many traders, so it is worth exploring the competing services on offer. The first observation to make is GSLs do not come cheap and you can easily end up paying more than the dealing commission for such a guarantee.
Dealing commissions
TD Waterhouse and Barclays Stockbrokers’ CFD accounts, for instance, have respective dealing commissions of 0.2% and 0.15% for UK shares versus GSL premiums starting at 0.25%. This premium is likely to be typical of the services provided by the traditional private client stock brokers as TD and Barclays, like many of their rivals, have their CFD platform provided by derivatives specialist City Index under a white label agreement.
These GSL premiums are just a starting point. If you want to deal in smaller and more volatile shares the premium can easily be a multiple of the basic price. TD, for instance, is currently charging a 1% GSL fee on UK banks Barclays (BARC), HSBC (HSBA) and Lloyds Banking (LLOY) and will not offer a guarantee on Royal Bank of Scotland (RBS).
Premium charge
Brokers typically have the same charges for GSLs across their CFD and spread betting accounts although the charging structure differs for spread bets on indices. For a spread bet on Barclays, for example, TD will charge the same 1% commission as for a CFD, but if you wish to take a position on its FTSE 100 daily product the GSL is worked out as two times the £/point being staked. That means at the current level of 4,000 you would need to bet £2.5 a point to get a £10,000 exposure, and the charge for the GSL would be £5, which is equivalent to a
0.05% commission.
And different brokers will charge in different ways. While TD will charge you £5 on the account statement, IG Index adds two points into the spread on its FTSE 100 daily product, so in effect any gains you make will be £5 less, or any losses £5 greater. You will therefore be paying as much again for a guarantee as you did in dealing charges given that both TD and IG charge a two-point spread on their FTSE 100 daily product as their brokerage charges.
Advanced traders will always have the choice as to whether to take out a GSL, but beginners will not. The starting spread betting package at IG Index is called a ‘limited risk account’ and unless you can prove to the broker you are already a sophisticated investor it says it is obliged to put you into such an account under Financial Services Authority regulations. Whenever you place a bet in a limited risk account you will have to take out a GSL, the reasoning, says IG, being to protect the novice trader from big losses.
Minimum stop
TD Waterhouse used to run limited risk account spread betting and CFD accounts, where it also stipulated the client take out a GSL, but now it only offers accounts where GSLs are voluntary. Whether you are forced into a GSL or not the next consideration the minimum stop distance allowed by the broker. This is clearly an important consideration when working out the maximum you are prepared to lose in the event a trade does not work out as planned.
For UK shares IG stipulates a minimum stop distance of between 5 – 12.5% depending on the share. For a volatile small cap this means you will be allowed to set the distance at 12.5% while for a blue chip the minimum is typically 5%. In comparison TD Waterhouse has a blanket 10% policy for all UK shares for its spread betting customers. The minimum stop distance varies across brokers for index bets too. IG allows a minimum stop distance of 10 points on its FTSE 100 daily product, equivalent to 0.25% at today’s level of 4,000, while TD will not allow stops inside 40 points or 1%.
Recent client behaviour on ShortsandLongs.com, where GSLs are free, reveals even during the extraordinary volatility of last October customers felt a 55.1 point stop on the FTSE 100 sufficient.
Whether an unnecessary insurance policy or not, GSLs are a popular tool among traders. Yet charges for GSL’s are not insignificant and can often double transactions costs. In many instances new traders will have to take out a GSL so it is worth shopping around to compare the various GSL options on offer.
GSLs and forex trading
Alex Poole
Currency pairs such as cable (GBP/USD) can be notoriously volatile so the case is perhaps strengthened for using guaranteed stops when dealing forex.
Because currency markets are open 24 hours a day Monday through Friday, visible or explicit gaps only occur when the markets reopen after the weekend. However, some very big moves can occur daily widening bid/offer spreads dramatically and such moves are, to all intents and purposes, gaps.
If you are in any doubt over the size of these moves, take a look at some recent intraday currency charts and check out those huge ‘candles’. A guaranteed stop would serve the trader well in such cases.
Traders with a longer time horizon should bear in mind the extreme volatility when setting their stop distances. A medium-term GBP/USD play, for instance, has no chance if the stop is set inside cable’s weekly trading range, which regularly exceeds 1,000 pips.
Impact of volatility
The impact of the extreme volatility following the collapse of Lehman Brothers in September 2008 can be seen in the trading patterns of ShortsandLongs.com customers. Clients of the spread betting platform run by Spreadex reigned in their risk taking on intra-day bets on the FTSE 100. During October – a month when the FTSE 100 moved 2% or more on 14 out of the 23 trading days – customers betting on ShortsandLongs.com’s daily FTSE 100 product placed average stop distances of 55.1 points. By December that had blown out to 77.1 points (see table below). A 22-point difference may not seem like much but in context of a quadrupling of bet size, from £2.19 to £9.31, it means traders who had been willing to stomach a £120.67 loss last October were prepared to lose £717.80 by December which was a considerably calmer month in which the FTSE 100 moved by 2% or more on only two occasions
