Guaranteed Stop Loss in Forex

Stop losses may be used as a capital preservation method to limit losses to a certain acceptable degree.

How the Stop Loss Works

Let us assume that a trader known as John is long on the EURUSD at 1.4590, with a stop loss set at 1.4550. If the trade goes south and the Euro loses ground against the US Dollar all the way to 1.4550, the broker acting as a counterparty will buy off the position from the trader at the lower price. Other times, the broker may match the order to sell off this position at the price of 1.4550 to another trader who is willing to buy at market price of 1.4550, or a trader with a pending order at the stop loss price. Given the liquidity of the forex market, it is not usually a problem to get the stop loss order fulfilled.

The process of executing the stop loss order occurs very fast; usually in a matter of milliseconds. The trader will lose 40 pips in this trade as a result.

When a Regular Stop Loss Fails

There will be occasions when a regular stop loss fails in the market. This occurs when the prices move so fast that it exceeds or overwhelms the broker’s ability to match a counter-order to execute the stop loss. This situation usually occurs when there is slippage or extreme volatility in the market as a result of a major market moving event. We saw an example of this condition on January 15, 2015 when the Swiss National Bank de-pegged the Swiss Franc from the Euro.

Many traders and brokers had long orders around the 1.2000 level, which was the level set by the SNB as the minimum peg for the EURCHF in September 2011. Faced with mounting cost of defending the peg, the SNB decided to jettison the move and this caused a drop of close to 3,000 pips on the EURCHF. This sudden move overwhelmed many brokers and some of those brokers who had no risk management procedures in place (such as reducing the leverage offered on such trades) were bankrupted by this move.

Similar moves have occurred in the past. Terrorist attacks and central bank interventions have led to such situations when slippages occurred, taking out stop losses and sending traders into loss positions beyond what was originally planned.

Guaranteed Stop Loss

This is why you are usually advised to trade with brokers that provide a guaranteed stop loss.  A guaranteed stop loss ensures that the price at which the trader sets the stop loss is the price at which it is executed. Even if the market gaps or undergoes a certain sharp rapid movement, the position will be closed at the stop loss.