Protecting shares with Guaranteed Stop Losses (GSLs)

Stop-Loss orders are a popular way for investors to manage the downside risk on their share investments and are a standard feature of many online trading platforms. A common shortcoming of Stop-Loss orders is that they do not offer complete protection when the market moves suddenly or gaps.

A popular alternative to the traditional stop-loss order is a relatively new feature called the Guaranteed Stop-Loss or GSL. A GSL will protect a share by guaranteeing a worst case outcome on a position during the term of the GSL.

GSLs can be incorporated into an investor’s strategy as a risk management tool that limits trading losses when unexpected market events occur.

A GSL can be set when opening a new position or can be added to an existing position in the market. Once a GSL is set, the GSL Level can effectively be moved online, allowing you to trail your protection level and lock in any profits.

How it works

A GSL will be triggered if the share trades at or below the GSL level. If the GSL is triggered, the position will be closed-out at the GSL price level – regardless of where the shares are actually trading.

The following chart demonstrates the difference when GSL protection is used and a share price suddenly falls.

The example illustrates a holding of BHP shares with a value of $200,000 and compares in one scenario a GSL at $19.80 and in the other scenario, no GSL is used. If the BHP share price suddenly drops to $18.00 the GSL would be triggered. You can see that the GSL effectively closes the position on a net basis at $19.80, the GSL level; however the position without a GSL would be valued at the market price, in this case $18.00. In this example, the loss on the position is dramatically reduced by using GSL protection.

Benefits of GSLs

Guaranteed Protection

A GSL guarantees the worst case outcome for a share position and can reduce the effect of share prices gapping. This protection holds during the term of the GSL regardless of what happens to the actual share price.

May be set as close as 1% from the current share price

The closest distance a GSL can be set to the share price is 1% which affords a high level of protection on your share investments. Additionally, this acts to reduce the collateral required for the position to as little as 1%.

Amendable at potentially no extra cost

Once a GSL has been set, if the share price moves, the GSL Level can be trailed behind the share price to lock in any profits. This change can be actioned online.

Can be placed online with a new order or added to an existing share position

The trading platform allows you to utilise a GSL when opening a new position or can be added to a new position. For existing share positions, you can use a GSL for part or all of the position.

Case Study

You should note that this example is illustrative only. It is not a recommendation to make any investment in any share, and should not be taken as personal advice. With a Macquarie Prime Facility, you are responsible for selecting the share for any position you take out. As such, the performance of any share position will depend mainly on your own investment decisions.

Jim and Jane both use Macquarie Prime to manage their share investments. Jim often likes to take risks and usually only trades with a stop-loss. Jane has a great aversion to risk and is very careful with her investing – never wanting to lose more money than she has budgeted for on a trade.

TLS is currently trading at $4.75 and both Jim and Jane decide to purchase 10,000 shares. They have separately identified $4.50 as a technical price barrier from which if struck, they see no near term recovery in the share price of TLS. As she is cautious, Jane purchases a GSL at $4.50 for 0.25%, which costs her $118.75 (10,000*0.25%*4.75). Jim sets a normal stop loss at $4.50 which has no cost.

Ten days later, TLS is trading at $4.55 and goes into a trading halt just before the market is due to close. A profit downgrade is announced and TLS resumes trading the next morning opening up at $4.40. Janes GSL triggers and her position is automatically closed at $4.50; Jim’s stop-loss is also triggered which automatically sends a sell order to the market which is filled at $4.39.

The following table illustrates how Jane’s GSL has protected her position and restricted her losses.