What Is a Stop Loss in Spread Betting?

In the context of this article, “spread betting” refers to the practice of wagering on the outcome of an event, such that the payoff depends upon the accuracy of the wager, not simply a win or lose outcome. It most often applies to financial markets (i.e., financial spread betting) and should not be confused with “betting the spread,” which in sporting parlance means a wager placed on the difference between the amount of points scored by each team in a matchup, plus or minus points assigned by an oddsmaker.

Financial spread betting is a form of speculation that carries considerable risk, much like derivatives or futures. On the other hand, it also offers the opportunity for potential gains far in excess of the stakes wagered. Currently, about one million gamblers participate in spread betting in the U.K., where it is regulated by the Financial Services Authority, not the Gambling Commission.

British businessman and politician Stewart Wheeler gets credit for introducing financial spread betting by founding the IG Index in 1974. His innovation made it possible to trade on the price of gold rather than the actual commodity itself. A bettor might wager £10 on every 10p the price of gold shifts, gaining when the price rises and losing when it declines. Theoretically, there is no limit to how much can be won on such a bet, although the potential losses could also be staggering.

For this reason, a form of order called a “stop loss” was developed. It allows the spread bettor to set a limit on how much can be lost. Assuming the spot price of gold stood at £924.75 and that £10-per-10p bettor could afford to lose no more than £2,000, he/she would place a stop-loss order at £904.75. The bet would be called off at that point and no more could be lost—a bit like taking out calamity insurance.

Since spread bets can be placed on either side of a market, up or down, stop losses are also used by bettors who short commodities, stocks or financial indices. If, for example, one believes the FTSE 100 index will fall, a stop loss order can be placed at some point above the current value to limit losses if it increases.

Some spread betting companies add a stop loss to any spread bet automatically, based upon the value of the bettor’s account or his/her credit line. This protects them against potential default in the event of a crisis.

One of the major risks of using stop loss orders is a “rebound.” When the market is volatile, a stock might lose 20% of its value during a morning of trading and recover it all (rebound) in the afternoon. If a stop loss is triggered when the price is falling, the bettor loses the entire stake before the stock has an opportunity to return to its original level.

Another problem with stop losses relates to overnight betting. If a wager continues while the market is closed, the spread betting company takes a commission based on LIBOR (London Interbank Offered Rate) plus a fixed percentage (say 0.67%). If the stop loss is triggered after a number days, these fees must still be paid, over and above the losses. Also, if the market opens at below the stop loss price, the bettor is liable for the difference in its entirety, not just the stop loss amount.

Stop losses can be adjusted—widened or tightened—depending upon the amount of money in the bettor’s account or value of collateral provided. A spread bettor must usually maintain a line of at least 5% to 10% of the total exposure taken, but it can be as high as 100% on illiquid stocks.

Published on: 06/07/2011

Related Articles