Lesson 10 of 13
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Using orders to manage risk (15)

Phillip Konchar

 

Using orders

The main risks we’ve detailed are related – leverage can compound market risk (a losing trade), an illiquid market can boost market risk, and so on.

Orders, if used in the right way, can be used as a powerful tool to manage multiple risks. We’ve gone into the basics of orders in our How Traders Interact with the Markets course, but as a reminder, this is how stop and limit orders work:

Using stop orders

Traders should always use a stop order, also known as a stop-loss order, to protect their downside market risk. Sometimes markets move quickly, or there is the temptation to wait for a losing trade to turn round. With a stop order, the decision is already made.

The key consideration when using stop orders is where to set them. Too close to the price and random price movements might trigger them, too far apart and losses might be more than the trader can take on one particular trade.

Always have a stop-loss order and never move it against your position once correctly set.

Note: a trader can move a stop-loss order in their favour to lock in profits.

Using limit orders

Limit orders help secure the upside and generally lock in profits. Traders can’t spend their whole day monitoring a market, setting a limit orders gives traders the comfort that if the price hits the order level then the broker will transact the trade.

All deal tickets will let you set both the stop and the limit order as you enter the initial trade – make sure you do this in line with your trading plan.

Gapping risk

Market prices can move quickly and no market is open 24/7. It is important to understand a standard order is only an instruction to your broker to trade, traders are not guaranteed to be filled at the order level specified.  In a fast market, or one that opens at a different price to its previous close a price might go through an order. In this scenario, you get the first price the broker can transact the trade at and not your order price.

This is called gapping. These gaps are normally for minimal differences, but occasionally markets can have large gaps – just look back at the Swiss Franc gapping that occurred when it unpegged.

Traders can manage gapping risk by using guaranteed stop orders – this when the broker guarantees the price specified in your order. This will cost you money but it might be worth considering if you are new to trading a volatile market.

Golden rule: setting stop orders

This is your choice, but we think new traders should not be risking more than 1% of their total capital on any individual trade.

For example, a trader with £10,000 capital will only ever risk £100 of it on a single trade. To achieve this when placing a £1 per point spread bet then they should set the stop order 100 points away.

Key Learning Points
  • Orders are a powerful risk management tool.
  • Avoid having an open trade without any orders to exit it in place.
  • Stop and limit orders can be set on the deal ticket when opening a trade.
  • Once set correctly, never move a stop order against your position.
  • Gapping risk occurs when prices jump through order levels.
  • Traders manage gapping risk by using guaranteed stop orders, but these cost money to place.
  • As a rule of thumb, we think new traders should not be risking more than 1% of their capital on a trade.

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