Mind the Gap…
What is a Gap?‘Gapping’ occurs when prices ‘gap’ or ‘jump’ or ‘slip’ from one level to the next without trading any prices in between.
With spread betting and CFDs this is also called ‘slippage’.
Gaps can cause problems because:
Why / When Do Markets Gap?
Examples of How Gaps Can Hurt Investors
Chart showing how Snap Inc. gapped lower after poor Q3 results
How to Protect Your Trades Against a Gap / Slippage
- Use a Guaranteed Stop order aka Guaranteed Stop Loss order aka ‘GSL’.
A Guaranteed Stop Loss order works in the same way as normal Stop Loss order, except that they ‘guarantee’ to close your trade at the level of the Stop, regardless of any gapping / slippage.
There is normally an extra cost for this level of insurance but Financial Spreads and IG now only charge their clients if the order is triggered. I.e. if you close a spread bet yourself, or if your spread bet hits a Limit (take profit) order, they won’t charge the Guaranteed Stop Loss fee.
At SpreadBetMagazine, we like this because it’s a bit like only paying for your car insurance if you have an accident.
- Consider adding a Guaranteed Stop Loss over the weekend. At the moment, only Financial Spreads will let you do this for free.
I.e. add a GSL to your trade before the market closes on the Friday. If the order is triggered then you still pay the fee (about 3-5 times your stake depending upon the market) but any losses will be limited.
If the GSL is not triggered over the weekend, just remove it on the Monday morning and use a normal Stop Loss.
(Remember, it doesn’t matter which spread betting firm you use, if the market is closed, you can’t add/adjust/remove a Guaranteed Stop or Stop Loss order.
- Consider closing your trades over the weekend. I know a number of professional traders who close trades on a Friday afternoon and then re-open them on a Monday morning. These traders are happy to accept the cost of closing and re-opening a trade vs the risk of a gap due to news that comes out over the weekend.
- Think again before you trade illiquid (less popular) markets e.g. soft commodities. These markets are more likely to gap. Companies with smaller market capitalisations are also more likely to gap.
- Think again before trading ahead of big news events like the monthly Nonfarm payrolls, these events often cause rapid market movements.
- Think again before trading in highly volatile markets, again, these are more likely to gap.
- Think again before trading US stocks that have large share prices e.g. Google’s $945 share price (see below for why a big share price causes problems).
- Try trading with a smaller stake size. Your potential profits won’t be as big but your potential losses, with or without gapping, will be smaller.
Don’t Forget to Use Stops or Guaranteed Stops
Why Are Gaps Such A Problem?A sudden movement in the market against your position, such as a gap or slip, could mean that you lose more than you deposited in your spread betting account.
The standard risk management order in spread betting, CFD and forex trading is the ‘Stop Loss’ order.
I.e. an order you add to your trades to close them at pre-determined levels. If you have a losing trade and the market hits the level of your Stop Loss it will close the trade.
This means that you are able to automatically close trades and cut your losses if the market moves against you.
These standard Stop Losses are not infallible though.
A Stop Loss order will close your trade at the best available price once the Stop Loss level has been hit.
In a normal market, your trade is closed at the same level of your Stop Loss.
If the market gaps across the level of your Stop Loss, i.e. the market doesn’t trade at the level of your Stop, your order will be placed at the ‘next‘ price level the market trades at.
If the market has a big gap, i.e. there’s a big slip from one price level to another, then your trade will be closed that next price level and your losses could be far larger than you expected.
Further Risk Management Guides
Snap Gap – A Longer Look at a Real Market GapSnap Inc. did not have a great IPO.
4 months after the messaging firm listed, even their lead underwriter, Morgan Stanley, downgraded the target price of the stock to $16 (below the $17 dollar IPO level).
The chart below shows how the stock gapped down overnight on the news of the downgrade.
I.e. it closed on the Monday at 1696¢ and on Tuesday it opened at 1631¢ i.e. a gap of 65 points.
Snap Gap I
Warning When Trading US StocksRemember, with spread betting and CFDs, when you trade US stocks, you normally trade per 1¢. While Snap fell 4%, luckily for investors, the stock was only priced at ~ $17.
Other US stocks have a much larger share price, e.g. the Google (Alphabet) stock is trading around the $945 level. If that fell 4% that would be a drop of $37.8… or put into spread betting terms… you could be nursing a loss 3,780 points = a loss of 3,780 x your stake!
Please be very careful when spread betting on US shares or… just don’t trade them.
Gapping AftershockOne gap was not enough for Snap.
The chart below shows how the market gapped lower again on the same Tuesday.
At 16:33 the price was 1592.5¢, it then gapped 28.5 points lower to 1564.0¢.
Snap Gap II
Worked Example of Gaps vs Guaranteed Stop and Stop Loss OrdersLet’s say you have bought Easyjet at 1750p and want 1500p to be your maximum loss level.
You could set a Stop Loss order to close your trade at 1500p.
You could also use a Guaranteed Stop order to ensure that if the Easyjet share price drops to 1500p, your spread betting platform, will automatically close out your trade at 1500p, irrespective of any gap.
Let’s say that there’s another ash cloud over Iceland, or perhaps a spike in crude oil prices, or another issue that hits the airline’s share price. If so, the share price could gap down from anywhere above 1501p to 1450p.
A Guaranteed Stop will close your trade at 1500p.
A normal Stop Loss order will close your trade at 1450p.
As an investor you need to judge the risk of a market gap vs the increased cost of using a Guaranteed Stop.
The Good News About Guaranteed Stop and Stop Loss OrdersNeither a Stop Loss or Guaranteed Stop will put a limit on your profits.
These orders are just there to help limit your downside, they don’t put a limit on your profits.
If you want to add an order to your trade so that it closes when it hits your target profit level, just use a ‘Limit order’, aka ‘Take Profit order’.
Remember: Spread betting, CFDs and forex trading carry a high level of risk. You can lose more than your initial investment. These products are not suitable for all investors. Only speculate with money that you can afford to lose. Make sure you fully understand the risks involved and seek independent financial advice where necessary.