Spread betting is an exciting and fast-paced method of trading which allows you to take a position without actually owning the options in question; the main advantage being that your initial deposit only needs to be a fraction of the actual price of the product.
This is known as leverage, and allows ambitious traders to considerably increase the size of their trade, whilst also increasing their exposure. Traders can therefore make a large profit from a relatively small investment; conversely, if the market moves in the opposite direction to the trade then sizeable losses can be incurred, which can exceed the initial investment. Therefore, while the potential risk is greater than in conventional trading, so is the potential reward.
What are spreads?
Traders are given a ‘buy’ and ‘sell’ price for every asset on offer.
If they feel that the asset will rise in value, they ‘buy’, in the hope that they will subsequently be able to ‘sell’ at a higher price, thus making a profit.
On the other hand, if they believe the asset’s value will fall, they will ‘sell’, aiming to later ‘buy’ back for less and therefore make money on the trade.
There is almost always a difference between the buy and sell prices, and that difference is called the ‘spread’. The smaller the difference between the buy and sell prices, the tighter the spread – this reduces your trading costs and increases the chances that your trade will be profitable if the markets move only slightly. ETX Capital is proud to offer a wide selection of competitively tight spreads for assets.
ETX Capital offers several different types of stops to traders. In order to demonstrate the differences between these forms of stops, let us take the following example, where I decide to buy gold at a level of 1315.7 and want to place a stop;
I place a regular stop-loss on the trade at a level of 1313.7, twenty pips below my purchase price. If the sell price of gold subsequently falls to that level, I will be automatically stopped out of the trade. It is important to remember that regular stops are not always guaranteed (see the guaranteed stops section for further details). Regular stop-loss parameters can be adjusted, but this would require me to actively move them to the new level.
Let’s say I decide to use a trailing stop instead of a regular stop-loss. With the current price at 1315.7, I place the trailing stop twenty pips away at the 1313.7 level.
Where trailing stops differ from regular stops is that if the market moves my way, a trailing stop will automatically move as well. To keep with our example, if gold then rises to a level of 1316.7, the stop level will rise to 1314.7, keeping pace with the rise whilst staying twenty pips away. Even if the markets subsequently fall, the stop-loss will stay at that new level of 1314.7 – unless, of course, the markets rise again beyond the 1316.7 level, in which case the trailing stop will move upwards to keep pace with the trade once again.
Trailing stops ensure that your trade will remain open as long as the markets are moving in your direction. They also ensure that traders don’t miss out on possible profits to be made through steep market fluctuations. For example, let’s say that the price of gold suddenly rose sharply to 1325.5, followed just as suddenly by a slump back to 1311.5. Had I been using a regular stop loss, I might have missed an excellent trading opportunity and ended up being closed out of the trade at my original stop loss level of 1313.7. However, with a trailing stop in place I could have benefited from that fluctuation, being closed out near the top of the trading curve at a level of 1323.5.
What happens if a piece of news with the ability to affect gold prices breaks after the market close? A regular stop could close out the trade as soon as the market opens – but there’s a chance that the market could open well below the set stop-loss level. A regular stop would then close at the first available price, meaning that your losses could exceed the initial deposit amount.
However, with a guaranteed stop in place, even if the markets opened below your stop-loss level the guaranteed stop will have closed you out of the trade at the level you originally set. Therefore, whilst regular stops are ideal for short-term trades, guaranteed stops are worth considering for long-term positions; though there is a small increase in trading cost, they do provide increased protection.
Stop orders to open
Stop orders work slightly differently to other forms of stops; they allow traders to open rather than close trades. For example, if gold is at the 1315.7 level, I could use a stop order to open to initiate buying if for example gold were to hit 1318.7. Alternatively I could use a stop order to open with a ‘sell’ position if for example the price of gold were to drop to 1312.7.
Why would one choose to open a trade at that point, rather than taking a position at the current and more favourable level?
The answer has to do with price fluctuations. If gold is at 1315.7 and has been hovering around that point for some time, I might not want to place a trade, given that I do not know what way the markets will move. However, if the price of gold suddenly rises to the 1318 level or falls to the 1312 level, this might be part of a larger rise or fall in gold prices and therefore would be an opportune moment to take a position in the metal. Having pre-established my stop to open at a precise level I would be able to capitalise on any general market movement in that direction. At the same time, if the markets were to move in the opposite direction, away from my pre-placed stop, it would not matter since the stop to open would then never come into effect at all.