Forex: guaranteed stop-loss vs non-guaranteed

Guaranteed stop-loss vs non-guaranteed in Forex trading

The foreign exchange market is not for traders and investors who lack passion and enthusiasm. A certain level of risk is always present in this market, as it is volatile and affected by a number of different factors. Luckily, there is a solution to keep your money involved in trading safe - a stop-loss order. What is a stop-loss order? It is an order placed with a Forex broker to sell a security when it reaches a particular price.

As you may already know, a stop-loss order is designed to limit an investor's loss on a position in a specific security. Though investors more commonly use stop-loss orders with long positions, they can also be applied to short ones, in which case the security would be purchased if it trades over a determined price. stop-loss orders, as well as guaranteed stop-loss, also eliminate emotions while making trading decisions, proving to be exceptionally useful when a trader cannot watch the position. A stop-loss is also often referred to as a stop order or stop market order.

Using a stop-loss order costs nothing to execute at all. Commission is charged only when the stop-loss price has been achieved and the currency pair must be sold. In other words, you can think of it as a free insurance policy.

Although it's good to not have to worry about your position with a stop-loss when you are not directly observing it, there is still a small disadvantage in its application, unlike the guaranteed stop-loss Forex. That disadvantage is that the stop price could be initiated by a short term fluctuation in a currency's price. Therefore, the key is selecting a stop-loss percentage that enables a stock to fluctuate normally, whilst preventing as much risk as possible. For example, establishing a 5% stop-loss on a currency pair that has a history of fluctuating approximately 10% or even more in a week is not the best idea. You will most likely end up losing money from the commissions generated from the implementation of your stop-loss orders.

There are no hard and swift rules for the level at which stops must be placed - this depends entirely on your personal trading style. For instance, an active trader may use 5%, whilst a long-term investor may choose 15% or even more.

Another thing to bear in mind is that as soon as your stop price is reached, your stop order turns out to be a market order and the price at which you sell might be a lot different from the stop price. This is particularly true in a fast-moving market, where currency prices can change in the blink of an eye.

In order to protect against unexpected occurrences, a trader can use a Forex guaranteed stop-loss. The purpose of this article is to detail the differences between the guaranteed and non-guaranteed stop-loss, and the benefits you could gain from using the former.

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What is the gap in FX trading?

Prior to describing the guaranteed stop-loss, we would like to briefly examine the Forex gap. In currency trading, the gap most commonly refers to the difference in price of a currency pair at the beginning of the new trading week, compared to the price at the preceding week's closing.

In the strictest sense, those gaps are not actually gaps. As a matter of fact, gaps are merely a change of market anticipation beyond a single pip. In your FX charts, it shows up as a disconnected progression of candles. You need to know that in order to better understand why you may need a Forex guaranteed stop-loss.

In the context of unfavourable developments, an event or accident might have so much influence that investors suddenly have a much different anticipation of exchange, resulting in a jump of ask/bid rates. In the context of weekend gaps, with various participants in mind, whilst the majority of retail Forex brokers are closed for the weekend, the reality is that the world continues revolving and economic or financial incidents will still happen. Without a guaranteed stop-loss, you will eventually lose a lot of money.

How can a trader handle FX gaps? No one can forecast what's going to happen in the foreign exchange market with 100% accuracy, so the best thing to do is to alleviate the risk of Forex gaps. It's for this reason that you need be consistent with practicing appropriate money management.

What does trading with guaranteed FX stop-losses represent?

What is a guaranteed stop-loss (we'll continue to refer to this as GSL)? It is a stop-loss that is generally your insurance against disastrous losses or large FX gaps in the market that you are currently trading. When volatility expands in a similar way to the start of the 2008 global financial crisis, you will find instruments such as stocks gapping permanently, as they continuously react to news from the US and London. For instance, when the US stock market falls over 350 points (around 3%), like it did on the 26 July 2008, you can anticipate your market is going to gap down substantially on open.

The market is a fine balance between sellers and buyers, also known as supply and demand. A gap up is the result of increased demand or more buyers flooding in, whereas a gap down results from more sellers or more supply hitting the market. It is at this point when the GSL comes into play. Before we continue, we should mention that not all brokers offer GSLs. Most often, it will be the market maker who offers this service.

A guaranteed stop-loss Forex is like an insurance policy. You take it out with the intention of protecting your trades, but hope to never have to use it. The main points of a GSL in currency trading are:

  • It can only be placed 5% away from the current close.
  • Its use is frequently at the discretion of your Forex broker.
  • Can be placed by phoning in, instead of online.
  • There can be time limitations. For instance, you may not be able to place a Forex guaranteed stop-loss within thirty minutes of the stock market closing.
  • Many Forex brokers do not offer GSL at all.
  • They tend to cost more to place than a standard order.

Knowing all that, let's consider who actually benefits from a GSL. The first group that comes to mind is traders who feel they need additional protection during times of uncertainty. It can also be useful for traders or speculators who trade with excessive amounts of leverage. The last group is traders who want a safety net for worst case stock market scenarios - i.e global crises, geopolitical and economic turmoil.

One may ask whether guaranteed stop-loss Forex are really necessary for FX trading. Many full-time Forex traders want to keep their trading costs low, so guaranteed stop-losses do not really have a place in their trading portfolio. However, it comes down to your own tolerance for risk, or even more importantly - your own desire to remove the worst case scenario.

However, you may not require GSL if you trade with little or no leverage, and instead only trade with rational positions. Also, if you trade with the trend and utilise stop-losses that permit you to cut your loss off short, a GSL is not something that is vital for your trading.

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Conclusion

As you can see, a stop-loss order, especially a guaranteed one is a simple tool, yet many investors fail to use it correctly. Whether preventing excessive amounts of losses, or just locking in profits, almost all investing styles can benefit from such a tool. Think of a stop-loss as a warranty. You hope you will never have to use it, but it is nice to know you have the protection should you need it.

If you trade with high levels of leverage, enjoy trading against the predominant trend, think selecting tops and bottoms a good way to make money, and are happy to cover the costs, then Forex guaranteed stop-loss is the exactly what you need.