Stop Loss Levels: A Necessity
If you have traded for CFDs or shares for any time at all, you will have come across the idea of a stop loss order. A stop loss order is an order to your broker to sell (if you have a long position) when the price drops to a certain level. This means that even if you are not watching the security, your broker will automatically close out your position for you, and you won’t be open to any further losses. If you are short a position, the same applies in reverse.
The stop loss order simply becomes a market order to sell when the price is reached. With a normal stop loss order, if the stock or index breaches your preset stop loss level then the order is executed at the next available price. This means that in fact moving markets the exit order may be executed at a price lower than your stop loss price in the case of a long CFD position, or more than the stop loss price in the case of a short CFD position. All you can expect is for the broker to get the best available price for you, which will usually be reasonably near to the one you wanted. Even if you were watching the market every minute, this is the best you could do if you sold when the stop loss level was reached.
This is the way it works with any type of trading, including traditional share trading. If you choose to trade CFDs a stop loss order becomes even more important due to the mechanics of leverage potentially escalating the loss on a losing trade. If you miss exiting the market when holding shares, you just lose more of the value. If you don’t exit the market from a losing position in CFDs, you can lose more money than you have originally outlaid when entering the trade or have in your account. This is the negative side of leverage which you otherwise hope will help magnify profits significantly in relation to the small initial margin required to establish the trade.
So for instance, a CFD trader taking a long position of $20,000 with a margin requirement of 10% (10-times leverage) may only need to place a deposit margin of $2000. This implies that a move of 10% in the asset’s price will result in a 100% return (or loss) on the initial margin outlay. Naturally, here it is the downside that creates problems, so normally when you open a position with CFDs, you will also enter a stop loss order in case the price goes against you. This ensures that your trade is exited automatically should the market move against your position. Obviously, you hope the stop loss order will not be needed, but it’s inevitable that some of your trades will go against you. However, because of the leverage even a regular stop loss order can result in you losing a significant amount of money.
A common mistake amongst newbie traders is the tendency to focus exclusively on positive outcomes. People prefer to think about how they could spend their trading profits, while disregarding the fact that the market could move against their positions. More experienced traders will focus on the downside risk of each trade and make this this is within their predefined parameters.
It is important to acknowledge and accept the fact as early in your trading career as possible that losing trades are an inevitable reality of trading. As traders we always try to maximise the number of profitable trades while reducing the number of losing trades but the truth unfortunately is that there are too many variables that influence stock prices at any one time to be able to predict the the outcome of a trade with any reasonable certainty. As opposed to trying to focus on getting the market direction correct, it is advisable to instead focus on perfecting the things that you have control over. This, in a nutshell, means controlling your risk.
CFD Order Types Explained
When looking at CFD (contracts for difference) brokers, you should be aware of the types of orders you’ll need to place in your trading. When compared to stock or share trading, there are actually more order types available when it comes to CFDs.
When looking at CFD (contracts for difference) brokers, you should be aware of the types of orders you’ll need to place in your trading.
When compared to stock or share trading, there are actually more order types available when it comes to CFDs.
A market order is an order to buy or sell a stock or CFD immediately at the current market price.
Generally, they are placed during market hours. When you buy, you buy at the ask price, and when you sell, you sell at the bid price.
A limit order to buy (at a limit price) refers to an order to buy the stock or CFD if the price trades at or below the limit price.
A limit order to sell (at a limit price) refers to an order to sell the stock or CFD if the price trades at or above that limit price.
These orders may be used to enter a position, or to exit a position.
When used to exit a position, they’re also known as a take profit order.
A stop order to buy (at a stop price) refers to an order to buy the stock or CFD if the price trades at or above that stop price.
A stop order to sell (at a stop price) refers to an order to sell the stock or CFD if the price trades at or below that stop price.
These orders may be used to enter a position, or to exit a position.
When used to enter a position, they’re also known as a stop entry order, and when used to exit a position, they’re also known as a stop loss order.
If Done (Contingent) Orders
What is an If Done (Contingent Order)? These are orders that are active only after another order is filled, and are otherwise known as “if done” orders.
As an example, if you’re placing a limit order to enter a CFD in the evening with a CFD provider that allows orders to be placed when the market is closed, then you may want to place your stop loss order at the same time as well. In this instance, you only want that stop loss order to be active after you have actually enter the position.
So you can place a limit order to enter a CFD (that’s pending to be filled), and then youcan place a stop loss order as well, linked to the first order, as an “if done order”.
OCO (One Cancels the Other)
So what is an OCO (One Cancels the Other) order?. These orders mean that if one is done, the other order is cancelled.
For example, if you have a take profit order and a stop loss, and one is done, you will want the other to be cancelled. On many platforms this is implied so you don’t have to specifically name it as OCO, eg when you place an order to enter, it may ask for a stop and /or take profit order at the same time.
So have a look at the specific platform and see how to palce these orders.
What you can’t easily tell with CFD brokers or Providers
The actual way in which CFD providers execute or perform their orders may not be described clearly by all CFD brokers.
For example, one provider may fill a limit buy order if any price trades at that price you stated. However some providers require that the ask (or offer) price trades at that price before a limit buy order is filled. In most situations, you’ll probably never notice a difference if there’s enough liquidity and trading volume around the prive you wanted to buy at, and you’re filled at the price expected.
In some situations however, you may find that the low of the day was the price you wanted to buy at, but didn’t get in because of the rule we just described. The price just dipped to that level momentarily as a bid price reached that price, but the ask didn’t.
The only way to know these rules is if you ask in advance, or if you experience a situation like this, to then ask your CFD broker.
Stop Loss versus Guaranteed Stop Loss Orders
In addition to normal stop loss orders when you trade CFDs you are sometimes able to get what is called a ‘guaranteed stop loss‘. This sounds ideal, because it guarantees to sell your losing contract at the price you specify, regardless of whether the market ever traded at that level or just shot straight through. Guaranteed stop loss orders means that your position will still be closed at the chosen price which may not be the case with a simple stop loss.
As you can see, this is a type of insurance, and therefore there is a cost associated with it. The broker for his part still has to sell at the best price available and make up the difference, if there is any, so the charge to you and other traders covers the difference. You are charged for a guaranteed stop loss when you take out the position, which means less profit even if the CFD goes straight up and you never need the stop loss. Therefore some traders only use them if the market is very volatile or the price is subject to frequent gapping. Amongst others, this would include low-volume shares, mining stocks and commodities.
A Tragic Example of the Importance of Stop-Loss Exit Levels
The so-called luck of the Irish ran out for Sean Quinn, reputed to be Ireland’s richest man who built up a position in Anglo Irish Bank using CFDs. Quinn’s interest in Anglo was first reported in January 2007 when he was named as the mystery investor who had bought up 5% of the bank.
By 2008 the Quinn family had utilized contracts for differences build a position equivalent to about 25% of Anglo, but as the value of the bank plunged he was on the wrong end of the CFD deal. Quinn’s gamble on the share price going up backfired within months. On June 7, 2007, Anglo’s shares peaked at €17.53. Three months later, the share price started falling and it never recovered as the international banking sector collapsed, led by Bear Sterns in the United States and followed up Lehman Brothers. In July 2008 Quinn was forced to crystallise his losses by converting the CFDs into an ordinary 15% shareholding – a move which is reputed to have cost him circa 2.5bn euros (£2.2bn).