Is Guaranteed Stop Loss Better than Regular Stop Loss?

Guaranteed stop loss orders are used to ensure traders' protection from losses during uncertain market conditions. Are they better than regular stop loss orders?

Investing in the forex market always comes with risks due to unpredictable movements and market volatility. Traders who are unaware of this can easily caught up in the losing zone and lose their hard-earned money. Luckily, there are a number of safeguards available for traders to protect their position from inevitable risks.

One of the most essential tools which are undoubtedly very important in a successful risk management system is called stop loss. Brokerage firms typically allow traders to make stop loss orders which automatically close a position when it reaches a certain pre-determined level. The idea is to limit potential losses by closing the position before the market gets worse. This way, traders can avoid larger losses and manage their risks in a volatile market condition.

To cater different needs of traders, stop loss orders come in several types. Aside from the regular stop loss order, traders can also choose to open guaranteed stop loss order, which is often said to be more effective in keeping your losses at the desired level. Is it true, though?

How Stop Loss Order Works

Stop loss orders, often known as stop orders or stop market orders, are designed to limit an investor's loss on a position of a certain asset by closing the position once it reaches a certain level. The stop loss order becomes a market order once the targeted level is triggered.

For example, trader opens a position at $100 and sets a stop loss order at $95 to limit his losses to $5 per share. If the market goes against his favor and the price drops to $95, the stop loss order would protect the position by automatically selling the entire position.

Not only limiting losses, stop loss orders can also help control emotions when trading. Even better, the feature eliminates the need to monitor your position every single time so you could take some time away from the trading platform. It helps you to keep on track and prevent your judgment from being clouded by emotion. On top of it all, stop orders cost nothing to execute. Therefore, you can think of it as a free insurance policy that could save you from extreme losses.

While this concept works well most of the time, there are times when a regular stop loss order will get triggered at an unfavorable price due to short-term fluctuation in a currency's price. Such a condition typically occurs during high market volatility when the price can move unexpectedly in a blink of an eye. Even worse, this kind of circumstance could create a forex gap.

Understanding Forex Gap  

Basically, the forex gap refers to the difference in the price of a currency pair at the start of a new trading session compared to the price near the previous session's close. In reality, these gaps are not actually gaps, but they are simply a change of market anticipation beyond a single pip.

Some unfavorable conditions might cause traders to have different anticipation which could result in a huge jump in bid/ask rates. This typically happens on weekends since the forex market is open 24 hours a day and only shuts on weekends. While most brokers are closed for the weekend, the world continues to move. This means high-impact news or huge financial breakthroughs might still occur and cause market gaps.

The problem is that no one can predict the forex market with 100% accuracy, so the best thing one can do is mitigate the risk of forex gaps. This is where guaranteed stop loss plays a part.

What is Guaranteed Stop Loss Order?

Guaranteed stop loss (GSL) order is a type of stop loss order that gets triggered exactly at the pre-defined level, regardless of market volatility and price slippage. They work the same way as regular stop loss orders, but your exit is more guaranteed. So it basically gives you insurance against extremely unfavorable market conditions or large forex gaps in the market that you're currently trading.

While regular stop loss orders work fine most of the time, unexpected market movements and forex gaps can occur and trigger your stop loss order at a highly unfavorable price. To avoid this risk, you can use guaranteed stop loss orders that will automatically close your position and limit losses exactly at your desired price, regardless of underlying market conditions.

It is worth noting that not all brokers offer guaranteed stop loss and those who do typically will charge you extra costs for using guaranteed stop loss once the stop gets triggered. Aside from that, there are several factors that you should consider before using GSL:

• The stop loss can only be placed 5% away from the current close.
• You can place the order by phone instead of having to go online.
• Some brokers may impose time limitations. For example, you may not be able to place a GSL order within thirty minutes of the stock market closing.
• GSL tends to cost more than regular stop loss orders.

Considering all the pros and cons, guaranteed stop loss orders are most suitable for several groups of investors. The first group consists of traders that need extra protection during times of uncertainty. It is also a great tool for traders that use a high amount of leverage and those who want to avoid extreme market conditions such as geopolitical and economic turmoil, global crises, etc.

The Bottom Line

Guaranteed stop loss orders are a rather effective tool to limit your losses during market uncertainties. Unlike regular stop loss orders whose execution relies on the current bid/ask spread, guaranteed stop orders will always close the position exactly at the pre-determined price, so you can avoid slippages and unexpected market turbulences.

Guaranteed stop loss orders can be better than regular stop loss under certain conditions, that is if you're using any strategy that is sensitive to market fluctuation and is prepared to pay the extra cost. Otherwise, regular stop loss is quite enough to minimize your risks.