Contracts for difference

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12. Stop losses

Most short-term traders use stop losses as an essential part of their trading strategy:

• You can't watch the market every minute of the day.
• 'Cutting losses' is, along with 'running profits', an axiom of sound trading.
• If you don't have stops, it can be tempting psychologically to cling on to a losing position.

By placing a stop, you ensure that if the market moves against you, your position will be closed at the stop level without further instruction from you. Except it's not quite that simple!

• If you are trading CFDs of large companies, with high liquidity, simple stop losses should do the trick. Your broker should be able to close out your position at the price you specified.
• If you're trading CFDs in smaller, less liquid stocks, the price may drop so fast that your broker is unable to deal at the stop price you specified.

Suppose, for instance, that you buy CFDs in Company X plc at 244p. You are happy to let it trade around the 240-248 mark, but your charts tell you that if it drops below 235 it will have breached a support level and is likely to slide further. To cap your losses, you instruct your broker to close your position if the price hits 235p, knowing that if that happens you will have limited your loss to 9p.

What might happen, however, is that Company X's price descends from 244 straight to 219p without any trades being executed at 235p. In that situation, your broker will close your position at the best price possible, but that may be 219p and your losses would be 25p.

There is, however, a refinement of the ordinary stop loss which can rise to your rescue - the Guaranteed Stop Loss. With a guaranteed stop loss, your broker bears the risk of any fall beyond your stop loss price, so your loss really is limited. In the example above, even if the broker closed out at 219p, your loss would be limited to the drop from 244p to 235p.

Not all brokers offer guaranteed stop losses, and there is, of course a charge for them. Usually this charge is levied in the form of a higher commission on the trade, typically 0.35% on top of the standard commission of 0.25%.

1. What are CFDs? 2. The benefits of CFDs 3. Initial margin 4. Variation margin 5. Commission costs 6. Interest payments 7. Dividends 8. Example of a long and short trade 9. Comparison of CFDs to share investing 10. Comparison of CFD trading to spread betting 11. Types of order 12. Stop losses 13. Strategies: Pairs trading 14. Strategies: Hedging an equity portfolio 15. Opening an account with a broker 16. Conclusion

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