One group of spread betting traders advises that you should cut your losses (using a stop order) and run your profits (by not selling out of a profitable position too soon), and for longer-term ‘position traders’ this is good advice. Another group of traders advises that you will never go bust by taking a profit, and while this is not literally true, it is certainly useful advice for shorter-term ‘swing traders’ who look to notch up profits repeatedly while a stock is trading sideways within a range.
Banking a Profit with a Limit Order
When a trader opens a new trade, it is common for him at the same time to place a stop order (in case he is wrong) along with a limit order (in case he is right). If you’re expecting your trade to generate a 50-point profit, it may in some cases be wise to bank the profit as soon as it materializes rather than waiting for it to slip away.
So in this case you would position your limit order to sell, at the time you open the trade, at 50-points above your buying price – safe in the knowledge that the spread betting company or stockbroker will bank the profit on your behalf while you’re busy on the golf course.
The Swing Trading Example
In this concrete example, the trader places no ‘live’ trades at all but automates his swing trading strategy entirely using limit orders.
Having witnessed the price his chosen stock or other security oscillating within an identifiable trading range, he concludes that there is profit to be made by buying near the bottom of the trading range and then selling near the top of the trading range. He places a limit order to buy near (but within) the bottom of the range and a limit order to sell near (but within) the top of the range. He sits back and waits for these limit orders to play out and automatically bank his profit as shown in the following picture. And if it works, he can do the same thing again.
The Long and Short of It
My concrete example suggests a long-only swing trading strategy based on limit orders, and you should have spotted that there are additional profits to be made by the short trader on the way down in each cycle. To pull off this trick, your initial limit order to buy for £1-per-point may be accompanied by a limit order to sell for £2-per-point which will not only sell you out but also take you net short by £1-per-point at the top of each cycle. Your next limit order to buy for £2-per-point would reverse your position and take you net long at the bottom of the next cycle.
What if You Are Wrong?
This strategy will work until your chosen security ceases to trade within a range and embarks on a sustained up- or down-trend, at which time your final limit order will leave you exposed to an ever-increasing loss. The solution to this conundrum is to place stop orders just above and just below the trading range so as to get you out if you are wrong.
About the Author
Tony Loton is a prolific trader and financial writer, and author of the book “Position Trading” published by LOTONtech.