How to make a Whipsaw Profit

Whipsaw losses are the losses that you notch up by repeatedly buying high and selling low, which as we all know is exactly the opposite of what you should be doing. They occur like this:

You buy the FTSE 100 index (for example) at the 5000 price level with a protective stop order at 4900. You get stopped out, losing you £100, and the price rises again to 5000. Thinking that you stopped out for no good reason, you re-establish your long position at 5000 out of ‘fear of missing out’ on what must surely now be an up-trend. The price falls back again, triggers your stop order and loses you another £100, rises back to 5000 and you buy in again. And so on and so forth, as the index trades sideways in a 100-point range.

Few spread bettors realise that it is also possible to notch up “whipsaw profits” when a trade goes the wrong way and then promptly reverses after stopping you out. I discovered this phenomenon by accident while running a spread betting account that mandated the use of guaranteed stop orders on all trades – whether you liked it or not.

Consider the scenario depicted in the following chart. Take a look at the chart, and then I’ll explain what happened.

Overnight on 21 November 2011 the price of this stock “gapped down” from around 40p-per-share to just 10p-per-share. Because the trader had a guaranteed stop order at 35p, the spread betting company took a loss of 25 points when it closed the position. Having been stopped-out at 35p-per-share this canny trader immediately re-bought at the lower 10p-per-share and notched up a “whipsaw profit” when the price rebounded by between 10 and 15 points to part-close the gap. In a sense, then, it was the spread betting company and not the trader that got whipsawed out of the trade at a loss.

It gets better, because when a price gaps down like this the spread betting company will not necessarily stop you out at all at the lower price. They’re not really breaking their promise here because if they do stop you out then it has to be at your guaranteed price level, but they don’t have to stop you out until they have seen whether or not the price rebounds. This can work to your advantage if your original trade is left “in play” when you establish a second position at the gapped-down price and subsequently get to run a profit on both positions.