For traders, managing risk is absolutely essential. You may think that you’re onto a winning position, but if things go the wrong way then you want to make sure that your losses are limited. Traders use stop losses to achieve this, ensuring that they exit their position if the market moves in the wrong direction.
Regular stop losses aren’t guaranteed
However, the problem with placing stop losses on a trade is that you don’t guarantee a maximum loss under all market conditions. If a market moves very suddenly in one direction, then the problem is that there may not be any traders on the other side who are willing to help you close your position at the stop loss exit price. While this doesn’t happen frequently in intra-day trading, if it does then you are potentially facing a loss that is much larger than you expected.
Trading gaps
Even more concerning is the possibility that an equity or forex price will gap up or down. For example, let’s assume that you have bought a particular stock, and there is earning news after the bell. If things go as you expect, then you’re going to rack up a profit when the results match analysts’ expectations. On the other hand, if there is unexpected surprise, then you’re exposed to a major downdraft.
The exact same issue applies in forex markets. While currencies are traded 24 hours a day, seven days a week, there is still the potential for a particular currency pair to gap – a significant rise of fall can occur without any opportunity to exit your position. This is even more problematic if you want to hold your positions open over the weekend – you could face significant losses if the currency pair opens significantly above or below its previous value on Monday morning.
Real-world examples of where a guaranteed stop loss will help you
There are a number of good examples where a guaranteed stop loss can help you to limit your losses. For example, consider the case of the decision of the Swiss Central Bank to decouple the valuation of the Swiss franc from the euro. This caught many investors unawares, leading to huge losses. However, if you had a guaranteed stop-loss in place, then there is a very good chance that you would have avoided the worst repercussions of this currency move.
