Head of CMC Markets Canada explains the powerful risk-mitigation potential of guaranteed stop-loss orders
There’s a powerful saying among followers of Zen Buddhism, which actually originated from American naturalist John Burroughs: “leap and the net will appear.” As useful as that mindset may be in life, it’s not one that investors will want to embrace all the time, which is why stop-loss orders – an order to sell a particular holding if it falls to a certain price – are a staple function in brokerage platforms.
Of course, stop-loss orders aren’t perfect. One glaring chink in their armour comes from their vulnerability to gapping: if the market for a certain asset or holding suddenly tanks after trading hours, and it opens the next day at a price below what’s set out in the stop-loss order, the trader’s position will still be closed at that much lower price.
That was the scenario that played out in March, when Saudi and Russia kicked off an oil-production war just as demand for the commodity had cratered to historic levels due to COVID-19-induced shutdowns and lockdowns. For a brief but painful period, crude prices sank into negative territory, and a lot of Canadian investors felt the hurt.
“Oil is a very popular product for Canadian clients … we’re a very commodity-based economy,” said Michael Yeung, Head of CMC Markets Canada. “A bulk of our clients were long oil at the time, so they took a beating. And given how quickly oil dropped, no stop-loss order they placed then could have protected against the slippage that happened. “
Since then, however, CMC Markets Canada has launched a souped-up version of the stop-loss order. For the first time, Canadian traders are being offered access to guaranteed stop-loss orders (GSLO), which offer an ironclad assurance from the platform that the maximum loss a trader specifies on a position will be locked in, no matter how the market behaves.
Adapting an international solution
“CMC has offered it for a long, long time in other jurisdictions internationally,” Yeung said, referring to other countries around the world where CMC also operates. “The only reason we haven’t offered it in Canada was because of the conservative thinking among our regulators here.”
As he explained, regulators in other jurisdictions accept that when a GSLO is in place, normal margin requirements for leveraged trading can be relaxed, since the trader is effectively taking on less risk. But the Investment Industry Regulatory Organization of Canada (IIROC), he said, took a harder line by requiring the same margin levels even if a GSLO is in effect.
“We’ve done a lot of back-end changes to adapt to changing regulations in our industry, especially in Europe,” Yeung said. “We’ve been able to accommodate IIROC’s rule, which is why we’re now able to offer it. To be honest, I wish it could’ve been even a little bit earlier.”
The first half of 2020 has seen a major comeback of market volatility, with unexpected moves coming in at a much greater frequency than seen in the relatively sleepy decade that preceded it. The events of the past few months have left many shaken, and the idea of risk has moved from the back of clients’ minds to the front.
And while the speculative and derivatives trading industry is at a more mature stage in Asia-Pacific regions including Australia, New Zealand, and Singapore – CMC Markets has footholds in all three of those jurisdictions – many Canadians are now shedding their traditionally conservative positions. According to Yeung, account opening rates at CMC Markets Canada since March has quadrupled compared to normal levels seen last year.
“Maybe a lot of people are stuck at home now and can pay more attention to their own individual investments, or a lot of people who were in very passive investments could have found themselves burned by how the broader markets have moved,” Yeung said. “It’s probably a combination of reasons, but this space is definitely growing now, and we only expect this to continue as people get used to it and we start to market as well.”
Nudging clients towards better risk management
The GSLO option offered by CMC Markets puts it a cut above the rest in Canada; even outside the country, very few dealers have the ability to offer it. As Yeung explained, CMC’s international base of over 80,000 clients allows it to hedge a substantial proportion of the trades it receives internally. It also leans on “some very clever systems” to spread and manage that risk, including solid quant capabilities.
But even that extensive risk-management toolkit can only go so far. The cost of hedging might be too exorbitant in some cases, or there may be limitations to the ability to hedge or short a particular product. This is particularly a problem for asset classes that are too illiquid or whose trading volumes are too low. Users of the platform are informed in real time if the GSLO is unavailable for a particular position they want to put in place, whether they’re using their phones or their computers to access the platform.
Still, Yeung said, CMC Markets Canada does its best to provide the option for all the products it offers exposure to, including individual stocks, U.S. indexes, commodities, and foreign exchange. He added that there’s no minimum account size a trader has to have before they can start seeing the option on their dashboards.
“And the nice thing about how we’ve done our guaranteed stop losses is that if you don’t use it, we refund the money you paid for it,” he added. “Years ago, our clients in other markets paid their upfront premium and got no opportunity for a refund. Then they were offered a 50% refund, and now it’s a total money-back guarantee.”
By offering those for the GSLO, Yeung said, CMC Markets is opening itself up to more possibilities of losses. Depending on the orders that come in, the brokerage may have to take on some options or employ some other external hedging methods. That adds to the cost of business, though it’s an acceptable price given the platform’s desire to make better decisions for its clients.
“Based on statistics on client activity, we know that those who manage their risks do quite a bit better in the long run,” Yeung said. “We provide training and speak to our premium clients, encouraging them to use stop-loss orders. But there’s a massive mental barrier that prevents many clients from closing their positions at losses, so the hope is that more people will see this option and not leave it on the table … I see no reason not to use it, to be honest.”
