Mind the Gap! Protecting Your Trades From Market Gapping

LONDON, January 30, 2012 /PRNewswire/ --

Market gapping typically occurs because of major news or economic data creating significant price movements as prices jump from one level to another, without trading in between. Here, City Index explains how you could use guaranteed stop losses to protect your trades against the dangers of market gapping.

Market gapping occurs when prices 'gap' or 'jump' from one level to the next, without ever trading in between and is typically the result of a number of important factors that can affect near term share demand. Markets can gap-up or gap-down due to a wide range of factors including economic reports, news on the economy, political news, or major world events.

Risk management orders including standard stop losses can be used to close your trades at pre-determined levels. Stop losses are used to reduce risk by closing a losing trade once a market passes a trigger value set by you. This means that you are able to automatically close trades and cut your losses if the market moves against you, helping you to limit your downside potential. Standard stop losses are not infallible though, because the order will close your trade at the best available price once the stop value has been triggered. Due to market gapping, your trade could sometimes be closed out at a level that is different from your trigger value. So if the market does gap, your closing price could differ from the trigger value you have set and therefore realising a deeper loss than your original stop loss dictated.

For traders spread betting in the UK, market gapping can have a damaging impact on trades. Because spread betting is a leveraged product, it involves a higher degree of trading risk as compared to other regular forms of trading. This is due to the fact that while you are only required to deposit a small margin to trade, your true exposure remains the full value of your trade.

A sudden movement in the market against your position, such as gapping, could mean that you may lose more than the amount of funds held in your account.

Naturally, traders will want to manage their spread betting positions very closely as the financial markets have witnessed a high level of volatility recently, creating significant price movements in everything from indices and equities to currencies and commodities. For a spread bettor, the potential to profit is high, but so is the potential to make sizeable losses if your trades are not managed appropriately.

Guaranteed Stop Loss Orders are the most efficient risk management tools available. They work in the same way as Standard Stop Loss Orders, except they guarantee to close your trade at the trigger value you have set, regardless of underlying market volatility and gapping.

For example, let's say you have bought a Rio Tinto spread bet at 3750p and have highlighted 3500p as your maximum loss level.

You can use a Guaranteed Stop Loss Order to ensure that should Rio Tinto reach 3500p, our systems will automatically close out your trade at this level, to prevent you from incurring any further losses.

Unfortunately some bad copper production figures push Rio Tinto lower to 3450p, and our systems automatically close your position out at 3500p.

Even though Rio Tinto's share prices continued to trade past your maximum risk allowance, the Guaranteed Stop Loss has already stopped your losses by automatically closing out your trade.

To limit your trading risk, consider a Guaranteed Stop Loss when you open a new position. This will help protect you if the price moves against you. For this added insurance, Guaranteed Stop Loss Orders incur a small premium (debited from your cash balance), upon confirmation of the order, and minimum distances apply.

Standard stop losses are useful tools in helping traders manage the risks of spread betting in a volatile market. However, if there the market is particularly volatile, it may be worthwhile to use guaranteed stop losses to protect your accounts from regularly occurring gaps in the market. Spread betting is a leveraged product which can result in losses greater than your initial deposit. So ensure that you fully understand the risks.

Learn more about spread betting at City Index. Visit: http://www.cityindex.co.uk/spread-betting/

About City Index:

Today more and more individual traders are discovering the benefits of derivatives, and many of them are discovering them through a City Index trading platform.

As a group, we transact in excess of 1.5 million trades every month for individuals in over 50 countries worldwide. We provide access to a wide range of instruments including margined foreign exchange, CFD trading and, in the UK, financial spread betting.

We constantly look to improve the performance of our platforms and expand the range of services we provide. The result is that our customers benefit from innovative trading tools with transparent pricing, competitive spreads, and a high standard of customer service and support. Visit http://www.cityindex.co.uk/ for more information.