The crucial role of a stop loss when you spread trade

Julie Brownlee, Fsp Invest, 08 May. 2014

Tags: stop loss, spread trade, spread trading, trading strategy, guaranteed stop loss, risk management, trade

When you buy shares for the long-term, a stop loss can make good risk management sense. When you trade, a stop loss is absolutely essential. Spread trading, and other geared financial products, work by multiplying the underlying assets movements. This multiplying effect can mean fantastic profits. But equally so it can mean huge losses. And that’s why when you spread trade you must use a strict stop loss. Let’s take a closer look at how you can do this when you spread trade…

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You should always trade with a stop loss

A stop loss protects you in the event that your trade goes against you. It limits your losses. And stop losses are a vital part of risk management when you spread trade, the team of experts at Money Week explain.

When you place a trade with your spread trading provider, you can put your stop loss level in. You may find that you can’t place a trade unless you enter a stop loss level.

A stop loss is an instruction to your spread trading provider to close your trade if it goes against you by a certain amount.

A stop loss in action

Let’s look at how a stop loss works and what your losses would be…

You put a long trade on the FTSE 100 index at 6,650 at R10 a point. You decide to put your stop loss at 6,630, 20 points below your entry level.

This means if the trade doesn’t work out as planned and it hits the stop loss, you’ll lose R200 (20 x R10).

When placing a stop loss, there’s one thing that you need to bear in mind. If your trade hits its stop loss, you might not always get out at the level you specified.

When the markets are volatile or illiquid, the price can sometimes gap past your stop loss. If this happens, your loss will be bigger than you anticipated.

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You could pay more for a guaranteed stop loss

Your spread trading provider may offer guaranteed stop losses. This means your provider will exit you out of your trade at your exact stop loss level, but this does cost you more.

This is something you’d have to weigh up before putting a trade on.

So there you have it, the crucial role of a stop loss when you spread trade.

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