Spread betting

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18. Strategy - stop losses and limited risk bets

Stop losses are used by active traders to make sure that their losses don't run out of control. The premise is straightforward:

• At the time you place your bet, you instruct your indexation company to close out a bet if the spread reaches a certain level.
• If you placed a buy bet, and the spread falls to your stop loss level, the indexation company will automatically input a sell bet.
• If you placed a sell bet, and the spread rises to your stop loss level, the indexation company will automatically input a buy bet.

The effect either way will be to crystallise your losses at the time of the second bet. Any further losses on your first bet will be neutralised by the mirroring second bet. Usually stops are put in at the time you place a bet but they can be put in subsequently, and they can also be changed or cancelled half way through a bet.

Note that the indexation companies offer no guarantee that they will fulfil your stop loss. If the market is moving very fast, they may not be able to close out your position at the level requested. They will do their best, but you may end up with losses higher than you allowed for.

A variation of the stop loss is the controlled or limited risk bet. Here you instruct the indexation company to close out your bet if your losses reach a certain level and, importantly, with this kind of bet, there is a guarantee.

• Suppose you think that Nasdaq is going to rise in the next quarter and you find a spread quote of 3,170 - 3,220.
• You don't want to lose more than £1,000 so you ask for a controlled risk bet. The indexation company takes the middle figure in its spread (3,195 in this case), deducts its controlled risk spread - say 18 points - and offers a buy price of 3,177. That's the price you bet at.
• If your stake was £10 per point, your losses will hit £1,000 if the spread descends to 3077. This would be 100 points off your buy price of 3177.
• Under the terms of the controlled risk, the indexation company will automatically close out your bet when the spread reaches 3077. You will owe £1,000, but you will at least be protected from the consequences of further falls in the Nasdaq.

Remember - the indexation company makes its money from the spread which is an intrinsic part of any bet. It has no interest at all in seeing its clients take large losses, because those clients won't trade again.

1. What is spread betting? 2. A brief history 3. Spreads on individual equities 4. Spreads on an index 5. Performance spreads 6. Other financial spreads 7. Practical advantages - leverage 8. Practical advantages - going short 9. Practical advantages - hedging 10. Practical advantages - volatile markets 11. Practical advantages - tax 12. Dynamics - think short term 13. Dynamics - the size of the spread 14. Dynamics - upside and downside 15. Dynamics - length of bet 16. Strategy - bet only what you can afford 17. Strategy - cutting losses 18. Strategy - stop losses and limited risk bets 19. Strategy - taking profits 20. Strategy - arbitrage 21. Opening an account 22. Placing a bet and managing your account 23. Regulation 24. Some more tips 25. Conclusion

• The Investors Guide to Financial Spread Betting