Contracts for Difference have revolutionized the way people access the world’s markets all from a one trading account and along with this great product have come guaranteed stop losses.
A CFD (contract for difference) is a kind of derivative trading. CFD trading allows us to speculate on the growing or dropping rates of fast-moving financial instruments such as indices, precious metals, foreign currencies, energy carriers, cryptocurrencies.
Today we will have a look at the advantages of using a guaranteed stop loss (GSL) when trading CFDs.
What it is a Guaranteed Stop Loss?
A GSL as they are commonly referred is a stop that limits your absolute worst-case scenario when trading CFDs. It is designed to reduce the volatility of your portfolio during volatile times or if you are trading, stocks that have a tendency of gapping.
As a general rule a GSL can be placed from 1 to 5% away from the current price and most of the time your CFD broker will require that you place this trade over the phone. The reason they ask for you to place this trade over the phone is that not all GSL’s are accepted. Whilst it is unusual for your guaranteed stop loss to be declined, it is something to keep in mind if you choose to use one.
An example of a guaranteed stop loss
Let’s say you entered a CFD position at $10 and just before the market closed that day you thought there might be some increased volatility overnight and you decide to place a GSL. In this case, we will suggest that you can place it at a minimum of 5% away, which means the closest you could place your Stop is $9.50.
If there was a dramatic move overnight then it would be quite common to see your local market gap down on open. If our $10 stock happened to open at $9 the following morning then under normal trading conditions the first price available to get out would be $9 which means you would lose $1 per share CFD. In this case we were fortunate enough to place a GSL and our CFD broker would be obligated to guarantee an exit price of $9.50 which means we would save $.50 per share CFD.
Is there an extra charge to use a guaranteed stop loss?
As you can see from the example above the CFD broker has the potential to be out of pocket especially in cases where the CFD trade gaps significantly. So the only reason your CFD broker is willing to take on this additional risk is by charging you a premium for placing this trade. You can expect to pay at least 2 to 5 times the cost of normal brokerage depending on your CFD broker. This additional cost can be seen as an additional insurance policy against large losses on your CFD trading account.
