CFD Trading – What You Should Know: Stop Loss

CFD trading is always highly speculative. The trader can try to contain the risk of complete loss, but he cannot eliminate it. An exciting fun activity with the potential to be addictive: high chances of winning and high risks of losing. So don’t be fooled! Be embarrassed!

Invest only money that you can afford to lose.

You should definitely know that

1.) Not the same thing: stop-loss on exchanges and stop-loss when trading CFDs

a) Stop-loss orders on the exchanges:

Stop-loss orders are a common tool used by exchanges when trying to limit the loss (or lock in profit) on an open position to a desired or commercially reasonable level. This trading strategy can be used on all major exchanges for all products traded there (stocks, indices, derivatives, futures).

Due to the execution regulations of the stop order, it can happen that the order is not executed exactly at the required stop price, but can deviate from it. A stop loss order is triggered when the stop price is traded on the exchange for the first time or when it drops below it. Then the stop order becomes an “at best” order, which means that the sell order with no price limit must now be executed as quickly and at the best possible price. Then the execution price depends on the current order status of the active market participants at that time.

Therefore, the evolution of prices in these exchanges is said to be system-driven. All transactions on these exchanges are recorded and can be viewed at any time, eg b. If there are doubts about the execution price of the stop-loss order, then this can be checked with the help of the trading history, the so-called “time and sales report”. In this report, all transactions are archived to the second with time, price and trading volume.

b) Stop Loss orders for CFD transactions

On the other hand, CFD transactions are not like those on an exchange. This is because they do not occur in exchange. Instead, the CFD provider provides the prices at which private investors can open or close a CFD transaction.

In principle, these prices can be based on the exchange rates of the respective reference markets, but the CFD provider maintains a degree of discretion when determining the price.

Technically, a CFD provider acts as a market maker (or an intermediary between a market maker and retail investors) and offers (non-binding) bid and ask prices at which they are willing to buy or sell a CFD product to retail investors. Then the market maker takes advantage of the differences between the bid and ask prices.

Therefore, when a retail investor places a stop-loss order to sell his open position, he gives the order to the counterparty from whom he bought the open position, who thus knows exactly what his open position is, and whose profits are usually instantaneously correlated with the losses of the private investor.

Sometimes the stop is triggered by the market makers i.e. at the ‘best’ sell order, when the stop price is trading, and sometimes the stop is triggered by the market makers when the bid price matches the stop price.

The market maker then has a degree of discretion when executing the stop order, especially if there are significant price fluctuations in the reference market at that time. Since unfavorable execution i.e. poor execution of sell stop will result in greater loss to the private investor than planned and to the market maker as a direct counterparty greater profit, it cannot be excluded that market makers will again and again use their discretion for their own benefit and at the expense of the private investor exploiting it.

So there is a significant conflict of interest in the execution of orders.

2) Comparison: Stop Loss on the Stock Exchange and in CFD Trading:

a) It is not possible to verify due to lack of trading protocols in case of CFD trading:

Unlike stock market transactions where official trading records are generated as described above, CFD trading does not contain such records. In the event of disagreements or doubts about execution prices, rather than as much transparency as possible, at best, if anything, the hope is a good faith resolution.

b) Price setting is subject to price control in CFD trading

Whereas in stock exchange transactions, price determination is controlled based on the orders of market participants active at the time, in CFD trading, price determination is controlled (“bid-driven”) by the market maker, who sets bid and ask prices With associated sizes without you being obligated to do so.

c) The condition of the best possible execution of orders for the client does not work in CFD trading due to the lack of other marketsR

Since there is only one place of execution available for CFD transactions, i.e. the CFD provider itself as the market maker or market maker authorized by it in the intermediary position, the requirement for best possible execution in favor of the client (“best execution”) is not fulfilled or It is circumvented in the competition between different markets, that there is even a conflict of interest between the CFD provider and the client.

3.) Guaranteed Stop Loss – The Invention of CFD Beginners:

However, the market maker can also easily execute a stop-loss order at the stop price and dispense with discretion, as described in the “Guaranteed Stop-Loss Orders” offered by some CFD providers.

Guaranteed stop-loss orders are not allowed on any regulated exchange, they are practically an “invention” of CFD providers. With these orders, we ensure that the stop is executed exactly at the stop price, regardless of whether that price is possible or tradable at all in the reference market.

For example, a retail investor bought a hedged CFD product with a guaranteed stop loss of €100.00 and closed that product at €101.00 that day without having a stop loss. The next day, due to unfavorable news on the reference market, the underlying opens at €90.00, so there is no trading between €101.00 and €90.00 in the reference market. However, the guaranteed stop loss is executed at €100.00, regardless of the path of the reference market. The CFD provider therefore waives the discretion. For this waiver, it asks for a fee from the private investor as a “compensation,” which is based on a percentage of the order size.

There is another aspect at play here. After placing a guaranteed stop-loss order, the CFD provider no longer requires the normal margin, for example, 20% for a stock CFD, but only the difference between the purchase price and the guaranteed stop-loss price. If this difference is only 2%, for example, then a private investor can make up to 10 times more transactions with CFD shares with a guaranteed stop loss compared to transactions without such an action.

If the investor follows this “opportunity” and buys up to 10 times more transactions, this means that the income of the CFD provider doubles as well.

So if the private investor uses this “privilege” in whole or in part, the CFD provider will very quickly compensate for the loss of income due to the lack of discretion, while at the same time the risk of loss for the private investor increases due to the high number of trades.

Some CFD providers offer this option of a guaranteed stop-loss order only to private investors who previously classified themselves as “Professional Clients”. However, professional market participants prefer markets that offer them the highest level of security, highest transparency and highest trading volume. However, since CFD trading does not meet these three criteria in any way, CFD trading and “professional market participants” are in fact mutually exclusive.

Therefore, some CFD providers do not offer a “guaranteed stop-loss order” at all. The CFD provider that you now consider more trustworthy depends on your “own taste” and prior knowledge.

If you do not have this knowledge yet and are wondering about these events, it may be a good idea to have a business relationship with your internet broker and have their behavior towards you as a client examined.

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For the rest, be critical and stick with your money!

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