The significance of risk management and the part it plays in deciding a trader’s success struck me as I sat down to write this article on the complexities of currency trading. The risk may not be fully avoidable, but traders can reduce losses and increase gains by using techniques like Forex stop loss. Today, we’ll examine an important type of stop-loss that traders might employ in Forex, a guaranteed stop-loss.
What is a Guaranteed Stop Loss in Forex?
A guaranteed stop-loss order is a form of stop-loss order that, in spite of volatility and slippage, is executed precisely at the pre-specified price level. The same principles that govern standard stop-loss orders apply when utilizing guaranteed stop-loss orders, but your exit position is guaranteed.
In a typical stop-loss order, the underlying instrument is sold at a predetermined price level while you’re trading long and is purchased when you’re trading short. They help you reduce your losses and manage your risks. The bid/ask spread of your traded instrument, however, can widen dramatically and prompt a regular stop-loss order at an unfavorable level during periods of high market volatility and excessive slippage, such as around the release of big market reports.
Let’s say you buy euros at the asking price of $1.1522, if you decide to place a long EUR/USD at 1.1520/22. For instance, a stop-loss order placed at 1.1510 won’t be activated until the bid price (the price at which buyers wish to purchase an asset) crosses the stop-loss level. Therefore, stop-loss orders buy when a position is shorted and sell when a position is long in order to close a position.
The Forex Trading Gap
Those who are only beginning to understand the mechanics of chart construction will find the market gap to be extremely strange. There is a gap in the price movement, and its two ends are drastically different.
When there is little to no trading volume, a significant value jump takes place. For a variety of technical and fundamental reasons, gaps occur. These variables can consist of the imbalance between supply and demand, sudden economic report releases, the conclusion of a trading week, and so on.
The main risk for anyone using automated orders is that the gap will prevent their limit criteria from being met. The specified limit simply does not appear on the chart as a result of the large jump, which is the cause of this.
There is a need for an improved version of the standard Forex stop loss order because we already know that it is useless against market gapping. The guaranteed stop loss enters the picture at this stage.
Example of a Guaranteed Stop Loss in Forex?
There are two things we can be certain of a guaranteed stop-loss order will always be filled at the stated price, and it also greatly reduces the amount that will be lost. This indicates that while you can be confident you won’t lose a lot, you will still lose something.
Let’s examine three risk management strategies in the examples that are outlined below: no stop loss, also known as going with the flow; a regular stop-loss; and a guaranteed stop-loss order.
Examples
We will now consider the case of purchasing USD/EUR at 11026.5 for $10 per point. What happens to three distinct trades with various risk-reducing strategies when a random gap emerges and the price drops to 10073.7?
A trader will be forced to deal with the full range of negative effects related to the decline if there are no stop-loss orders at all. The total loss will be $9,528 after taking into account the price discrepancy and multiplying it by the cost per point.
Let’s now examine the scenario in which the order was executed at 10860.0 due to a slippage even though the regular stop loss was set at 10950.0. As a result, the loss is $1,665, which is somewhat less serious.
At the exact same level as the conventional stop loss from the previous stage, which is 10950.0, the guaranteed stop loss order will be put to the test. The order is filled at the precise figure since there is a guarantee in place, increasing the losses to a total of $765.
Depending on the total amount in your account, $765 can still show a reduction. However, it starts to matter when you compare it with the difference of over $10k from the no stop-loss example or the $1,665 from an ordinary stop-loss.
From this illustration, it is reasonable to conclude that a guaranteed stop loss can be quite significant in the process of reducing risk. Traders shouldn’t ignore alternative means of securing their investments, though.
There are several different approaches to risk management in forex trading. ranging from the diversification of a portfolio to specific trading restrictions or specially created trading techniques. Make sure to choose a different strategy if you are uncomfortable with all the conditions of guaranteed stop-loss orders in forex.
What Does it Mean to Trade With a Guaranteed Stop Loss?
A guaranteed stop loss is a relatively uncommon tool in forex. Due to the difficulty of installation, few brokers offer it as a part of their services. However, it has shown to be remarkably successful in a lot of difficult situations.
Most of the time, market gaps close over time. A balance is always sought after by having an equal number of vendors and purchasers. However, there are also instances where higher volatility results in long-term gaps, like the 2008 financial crisis’s occurrences.
Therefore, the Forex order with a confirmed stop loss will act as a sort of insurance. The benefit of a guarantee is it allows a trader to be certain that the order will be filled at the desired price, regardless of gaps or extreme volatility.
It implies exactly what it sounds like when we say insurance: it’s wonderful to have, but ideally you’ll never need it. How come?
In forex, several requirements go along with guaranteed stop losses. Brokers typically do not provide a guaranteed stop-loss order mechanism, as we mentioned earlier. Instead, it comes from bigger market makers, who are typically difficult to contact.
There will also be several restrictions on how you can employ a guaranteed stop loss. You might, for instance, be forced to place the guaranteed stop loss within a specified time frame. A distance of more than 5% from the most recent closing price is likewise banned.
Last but not least, there is a cost associated with using a guaranteed stop-loss order as a risk management technique. The ordinary stop loss, however, doesn’t cost you anything and has no restrictions on how often or how much you can use it.
Benefits of Using a Guaranteed Stop Loss?
We now understand that a guaranteed stop-loss order can be viewed as a form of insurance. In many challenging situations, it acts as a protective strategy, although it has some drawbacks.
A guaranteed stop loss has advantages and disadvantages, just like any other risk management tool for the forex market. Volatility is often very harsh. Even professional Forex traders occasionally face market stress. A guaranteed stop loss will not in any way alter how the market is moving. However, it will protect your account balance from damaging blows.
Regular stop-loss orders must be physically filled in by the broker, so they cannot be activated during gaps. Paying for a GSL offers a special chance to be comfortable about absorbing small losses even in the most unpredictable situations.
To act as a safety net for both short and long positions, guaranteed stop loss functions in both directions. It’s crucial to remember, though, that a GSL cannot be applied to an open position. These stop losses may only be applied to fresh positions and are irreversible, although you can change the level on which they are placed.
This leads us to the further conclusion that a trader who employs GSLs can foresee the risk’s impact. Identifying the precise amount that is at risk is important when determining how to determine a stop loss in forex. However, this determination might not always be accurate in choppy markets. A guaranteed stop loss is the only instrument that will work in these circumstances.
Finally, the trader does not need to be in charge at all times when a guaranteed stop loss is used. A fast-moving chart can be highly stressful to watch. And increased stress is invariably followed by flawed judgment and analysis.
Conclusion
Stop losses are really helpful in forex trading, therefore you should absolutely learn how to apply them to your trades. Now, the guaranteed stop loss has both significant advantages and clear dangers, making it a technique that not everyone should use.
The bottom line is to make sure that your trading process is appropriately organized, regardless of the risk management strategy you select. When it comes to Forex in particular, it is always preferable to be careful than regretting it.
