Risk Management | Examples

Here is a scenario explaining how our stop orders work.

'Buying' US Light Crude oil with a stop

US Light Crude oil is trading at 10055-10059. Say you want to 'buy' £5 per point at 10059. Normally this would require a margin of £425 = 85 (margin factor) x £5 (bet size).

To reduce this initial payment, and to offer some protection against adverse market movements, you decide to place a stop 45 points away at 10014. As this is a non-guaranteed stop, you do not pay a dealing spread premium, but you have to take into account the possibility of 'slippage'. Every market will have a particular slippage factor, which we use to calculate the appropriate margin for particular products. You can find these on the 'Get info' screen for each product in our trading platform. In the case of Daily US Light Crude, it is 20%.

So to work out your new margin factor, simply take the distance of your stop from the opening price (45 points) and add a slippage factor of 17 points (20% of 85, the normal margin factor) = 62.

This means that the margin required would drop to £310 = 62 (margin factor including stop) x £5 (bet size).

You open the bet as the UK markets are starting to get going, but moments later China announces substantially lower-than-expected economic growth figures. On the back of this news, the price of oil begins to drop almost immediately. The market gaps repeatedly, and just a few minutes later the price plummets straight through your stop level to 10005 and then hits a low of 9945 within half an hour.

Because you chose not to pay a premium to make this a controlled risk bet, your position was affected by slippage and closed at 10005, nine points worse than the level of your stop. Your total loss was £270. Without this
stop in place, had you closed the position at 9945, your loss would have been £570.

Here is a scenario explaining how to 'lock in' profits in volatile markets using a trailing stop.

'Buying' EUR/USD with a Trailing Stop

Our EUR/USD forex price stands at 1.35815/1.35830.

You believe that the euro will rise against the dollar, so you decide to 'buy' at £20 per point. You decide to add a trailing stop, and choose to set one up at a distance of 30 points, with a step size of 10 points. The trailing stop initially sits 30 points behind your opening price, at 1.35530

Immediately the euro starts to strengthen against the dollar. Soon our price has risen to 1.35930 (10 points above your opening price) and your stop 'steps' up by 10 points to 1.35630 to re-establish a 30-point distance from the new market level.

The rally continues and by lunchtime EUR/USD is trading at 1.36460/1.36475. Your stop has therefore moved automatically five more times and you are now sitting on a healthy potential profit, with your trailing stop waiting 33 points behind the current 'sell' price, at 1.36130.

A surprise announcement that eurozone industrial output growth has fallen suddenly sends the euro plummeting and within minutes EUR/USD is trading back down at 1.35910/1.35925.

Your trailing stop has kicked in and your position is closed 33 points below the recent high at 1.36130, still well above your opening price of 1.35830.

Your profit on the trade is calculated as follows:

With a conventional stop order, unless you had moved it manually, you would still be in the market, looking at a relatively small paper profit. By contrast with a trailing stop you are able, in this scenario, to profit from a volatile market.

Remember, trailing stops are subject to slippage and could result in losses that exceed your initial deposit should the market move sharply against you.