Stop on Close (aka Stop Close Only) is a risk management technique used by swing and position traders. A Stop on Close is a stop order that uses the closing price as the stop trigger. The Stop on Close is not an intraday stop order actively working at the exchange, it is an end of day stop that is manually executed. For example, let’s say you are long Corn from $7.00/bushel. You have a stop on close at $6.85. If Corn closes at $6.85 or lower, then the trader would exit right before the close or on the open of the next trading session.
The benefit of this method is that you are not stopped out intraday if there is a quick spike down in prices but then the market comes back up by the end of the day. Let’s say you are long Corn from $7.00 and corn spikes down 20 cents intraday to $6.80 but then rallies 10 cents to $6.90 into the close. You will still be in your position at the end of the day because we closed at $6.90, which is above the $6.85 Stop on Close price.
The drawback of this method is that the market can continue to move against your stop throughout the day. If we are long corn from $7.00, our stop on close is $6.85, and we close at $6.75, that is 10 cents past our stop. Our stop on close was 15 cents, but the actual loss is going to be 25 cents in this case.
If you use a Stop on Close, it’s possible you will be stopped out less due to intra-day (and overnight) spikes in the market. However, when the market goes against you, the losses tend to be a little larger than the stop price. That is the tradeoff between a regular stop and the stop on close method.
Stop on Close can be used for straight futures contracts, but is most popular with Option, Option Spread and Future Spread traders. Options, Option Spread and Futures Spreads may not have stop orders accepted at the exchange, and if they did, you would not want to have a stop execute a market order for any of these trading strategies. When you trade Options, Option Spread and Future Spreads, it’s best to use Limit Orders.
With that said, a Stop on Close can be a very effective risk management tool for options traders and futures spread traders. Options and spreads tend to move slower than the futures contracts, so prices typically do not move against the trader as much. This allows traders the freedom to have a stop on close instead of a straight stop.
A stop on Close is a manual stop. It is not an order that the exchange executes like Market, Limit and Stop orders. Either the trader monitors the market or your broker does. Stop on Close can be executed in two different ways. If the stop is executed right at the end of the day, then it is probably apparent that the market will close past the stop. Alternatively, if the stop is executed after the close, then the stop is executed at the beginning of the next trading session. Both methods generate similar execution prices, so it is more preference than anything else. Most traders and brokers exit on the open of the next trading session simply because not everyone has the time to monitor the market in the last minute of trading.
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Stop/Loss Orders Risk Disclosure: STOP ORDERS DO NOT NECESSARILY LIMIT YOUR LOSS TO THE STOP PRICE BECAUSE STOP ORDERS, IF THE PRICE IS HIT, BECOME MARKET ORDERS AND, DEPENING ON MARKET CONDITIONS, THE ACTUAL FILL PRICE CAN BE DIFFERENT FROM THE STOP PRICE. IF A MARKET REACHED ITS DAILY PRICE FLUCTUATION LIMIT, A “LIMIT MOVE”, IT MAY BE IMPOSSIBLE TO EXECUTE A STOP LOSS ORDER.
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Options Risk Disclosure: An option on a commodity futures contract is a right, purchased for a certain price, to either buy or sell a commodity futures contract during a certain period of time for a fixed price. Although successful commodity options trading requires many of the same skills as does successful commodity futures trading, the risks involved are somewhat different. For example, if a customer buys an option (either to sell or purchase a futures contract or commodity), the customer will pay a “premium” representing the market value of the option. Unless the price of the futures contract underlying the options changes and it becomes profitable to exercise or offset the option before it expires, the customer’s account may lose the entire amount of such premium (together with the costs of commissions and fees incurred to purchase such options). Conversely, if a customer sells an option (either to sell or purchase a futures contract or commodity), the customer will be credited with the premium but will have to deposit margin due to its contingent liability to take or deliver the futures contract underlying the option in the event the option is exercised. The writer of the option is however at unlimited risk with respect to the call option written, and risk on the put option of the amount should the price of the futures contract drop to zero. Sellers of options are subject to the loss which occurs in the underlying futures position (less any premium received). The ability to trade in or exercise options may be restricted in the event that such trading on U.S. commodity exchanges is restricted by both the CFTC and such exchanges, and it has been at certain times in the past.
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