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Paul Beck

Should I use stop losses on Futures positions?

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Stop losses are an important tool and they can prevent your account being wiped out. With Futures positions the use of them can come into question especially if you’re using them as a hedge against another position. In that instance it might be counterproductive to apply stops to your positions. Should your strategy involve trading the Futures themselves then all the usual (very prudent) advice about using stop-losses applies. Say for example you are holding only Long Futures in Oil then a substantial market move against you could bring about substantial losses. Applying a stop loss should result in losses being limited. You’d also need to consider the technical details and whether you apply a Guaranteed Stop Loss or a Trailing Stop Loss. A good broker will make this functionality available to you and they are worth considering. In other scenarios it might be that the Future is held as a hedge of another position. Pairs trading is one strategy where a portfolio is hedged against market risk by simultaneously holding Long and Short positions that you would expect to mitigate a general market. One example would be going Long on the German Index and to Short the France Index. A shock event that causes the markets to rise or fall should (the theory goes) impact both Indices to a similar extent. The losses on one would be counteracted by the profits on the other. Your analysis would be aimed at seeing the German Index outperform the French Index and to take profits from the difference in relative performance. In the above scenario, should you set a stop loss on both positions then you could actually increase the risk of losses. Take for example, a Flash Crash where both markets fall substantially but soon return to their previous position. The Short Position in the France Index will move into profit but without being closed out at the market lows will then return to being flat of P&L. The Long Germany Index, should it have had a stop loss in place will also fall away with the rest of the markets, but losses would be crystalized should the stop loss be triggered. After being kicked out of your German Index position you would not benefit from the general market recovery.

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