A Guaranteed Stop provides a simple way to put an absolute limit on potential losses. The following example outlines how a Guaranteed Stop works in practice.
You think WXY Ltd looks a bargain stock, but are worried about the chances of a surprise downturn in the market. You want to open a position while guarding against sudden market moves.
Opening the position
WXY Ltd is trading in the market at $5.73/5.74. So you buy 2000 shares as a CFD at $5.74, the offer price, on a Limited Risk basis.
You place your Guaranteed Stop at $5.45. This means that, if the share price drops sharply, your exit price will be guaranteed at $5.45. So the most you can lose on the position (excluding interest and commission) is $580 ($5.74, the opening level, minus $5.45, the stop level = $0.29: $0.29 x 2000 shares = $580).
The standard commission rate on the transaction is 0.1% or $11.48 (2000 shares x $5.74 x 0.1%).The Limited Risk premium is also charged when the position is opened. In this case it is 0.3% or just above $34 (2000 shares x $5.74 x 0.3%). Remember this is a one-off charge: you can move the level of your Guaranteed Stop at no extra cost.
Triggering the Guaranteed Stop
After you have held the position for a few weeks, the whole stock market opens markedly lower one morning after negative overnight news. WXY Ltd closed the previous day at $5.55, but now opens at $5.30. Your Guaranteed Stop is triggered and your position is closed at $5.45, even though the market never traded there!
You sell 2000 shares at $5.45. The commission on the transaction is 0.1% or $10.90 (2000 shares x $5.45 x 0.1%). Your gross loss on the trade is calculated as follows:
Gross loss on trade
| Opening level | $5.74 |
| Closing level | $5.45 |
| Difference | $0.29 |
Gross loss on trade: $0.29 x 2000 = $580
Without the Guaranteed Stop, you would have been lucky in this example to close your position at $5.30, representing a loss on the position of around $880.
To calculate the net result of the transaction you also have to take into account the commission and Limited Risk premium you have paid and the interest and dividend adjustments. These adjustments are applied to Limited Risk positions in exactly the same way as to standard CFD positions (see Detailed Example).
Please note that examples quoted on this page are in Australian Dollars.