Your capital is at risk
February 26, 2016
You must always protect a new CFD position with a stop. This way you know the maximum amount of your loss beforehand. But only with a guaranteed stop can you be really sure of the exit rate.
Because of the leverage effect of CFDs, a small fluctuation in the markets can have a big impact on your trading capital. Sometimes it is positive, but sometimes it is also negative. If you do not protect a CFD position by setting a stop loss rate, with most investors you can lose even more money than what is on your account. Only Plus500 promises that you can never lose more money than what is on your account.
If you start with a long position with 50 dollars and set a stop at 45 dollars, then the sell order is sent as soon as the rate is under 45 dollars. Often, the stop rate is also the exit rate, but not always. In case of a 'gap', the market price suddenly makes a jump, which causes you to not be able to know your exit rate. Imagine that because of a scandal, the next day the share opens at 30 dollars, the position will then also be closed at a rate of 30 dollars.
Imagine that you bought 100 shares at 50 dollars each through a CFD. The stop rate is 45 and you risk losing 500 dollars on this trade. However, if the market suddenly dropped to 30, you would lose 20 dollars on 1 share, and the total loss would go up to 2,000 dollars. Imagine that you had only 1,000 dollars on your account, then you would suddenly owe your broker 1,000 dollars. Only with Plus500, it says in the terms and conditions that you can never loose more money than what you have on your account.
With a guaranteed stop, you know the absolute maximum value of your loss beforehand. If you want to close the trade when the rate falls under 45, the position will be closed at 45, even if the market suddenly falls to 30. The trade will be closed exactly at the stop level you set.
In order to be able to set a guaranteed stop, you must pay a little more. When opening the position the price will be a little higher because the spread between bid and ask increases. With a guaranteed stop, you also cannot set the stop rate close to the entry price. A normal stop, for example, can be set at a distance of 1 index point for a stock exchange index; a guaranteed stop, for example, can only be set at a distance of 5 to 10 points.
The 'gap' risk is high when trading individual shares. Therefore it is better to trade in indices, which somewhat decreases the risk of sharp fluctuations. However, you can never be sure that nothing negative is going to happen. An example from the beginning of 2015 was an intervention of the Central Bank of Switzerland. See the below graphic of the Plus500 platform.
Out of the blue, the central bank announced that it would take away the ceiling rate, because of which the rate basically immediately changed by several tens percent. The rate was around 1.2000, but was sent to 1.000 very rapidly.
Traders who had not set guaranteed stops, all of a sudden lost about 2,000, 3,000 or more pips.
Traders who limited their risk by working with relatively small positions, lost half or more of their account because the position was stopped at a totally different rate. For example, they were counting on a maximum loss of 200 dollars, but in the end they lost 2,500 dollars, which caused the balance on their account to be almost completely gone.
Traders who had made maximum use of the leverage - with an investment of 500 dollars it is easy to open a trade of 100,000 dollars - very quickly had losses of a few thousand dollars, often much more than what they had deposited onto their accounts. Suddenly they had a gigantic debt toward their broker!
Therefore, for your safety, you should always use a guaranteed stop.
CFDs are a leveraged product. Make sure you understand all the risks involved.
