Thursday, March 8, 2012


I just want to take a moment and reiterate the importance of stops.  This is a crazy market, with wild swings that will slit your trading throat in one overnight session.  The best way to protect yourself is with stops.

They can be hard stops or mental stops.  Each has advantages and disadvantages.  Figure out what works for you, and follow through.

I personally hate stops.  I can't tell you how many times I've put in a stop where I was sure it was in a unique, out-of-the-way spot, and then sat, stupefied, as the price raced down, took it out, and then raced back up.  I've had that happen where my stop was the low of the day!  You don't forget stuff like that.

Now, a few technical thoughts.  Stops are not there to prove that you know how to follow the rules and get an "A" from your teacher.  You use stops in the way that best protects yourself without depriving yourself of easy profits.  With that in mind, throw out all the things you read in books by "experts" who tell you to use a 10% stop, a 5% stop, a 6.3% stop.  Every situation is different.  You need to develop a feel for these things.

Let's say we are in a dicey play that lifts off, then falls back below our starting point, then lifts off again so that we have a moderate profit.  I would "tighten my stop" in this situation.  Under my scenario, let's assume the stock is 4.4% above where we bought it.  When I "tighten my stop," I refuse to put it at 9% below where it currently sits and watch helplessly as the stock does its usual swing back below my entry.  Even though it flies in the face of all orthodoxy, I will put it the stop little bit above my entry point.  This has the unfortunate result of giving the security less maneuvering room and vastly increases my chances of stopping out, but it also means I'm likely to get out without a loss, and even a small profit.  That is called "locking in a profit."  That is a good thing if you can do it.  It then becomes necessary to watch the stock and buy it lower, or move on to something else.

Or, in another situation, perhaps we have a runner that is up 10% but has a habit of quick, sharp pullbacks.  If I "tighten my stops" on this play, it means very close, within a few percent or just below some kind of known or reasonable support (say, a moving average).  The reason I won't give it much room is because of the character of the stock - it is either going up, or it is going down, and it tends not to dally within some range.

I like to give my plays lots of room, probably more than most people.  I find that in most market conditions, too tight of a stop will just cost you money that a little more patience and running room would have given you.  But you need to analyze the character of the stock's swings and make a judgment call.  Too much room can also cost you money if it isn't warranted.  If a stock has never, in the past five years, fallen below $15.20, then a stop at $15.10 makes sense even if it currently is trading at $15.30.  That may seem like no room at all, but if it breaks that support, something is wrong and you might as well get out.

On the other hand, suppose you are in an endless Bull market and there is sudden 5% market correction.  Your stock dives 8%, while normally you only like to give it 6%.  There is a reason to give it that extra room, and if you have a solid reason for doing so (it is right above solid support, it has a tendency to do these quick dives and quick recoveries, etc.), then you are fine.  Hoping and praying and wishing is not a solid reason.  The fact that in this trending market there have already been several pullbacks that have brought out the dip buyers and sent the market to new heights is a good reason.  But you can't just give anything endless room, we are talking about a reasonable, justifiable cushion, not an excuse to just let it take you anywhere it wants to go.  Anything more than 10% or something in that vicinity and you better have several good reasons, and even then think about it twice.

I could go on with more examples, but I think you get the point.  Analyze the market and the stock and get a feel for what it tends to do.  Identify support and resistance lines and use those to buy and sell.  Resistance lines are there on the chart for a reason - good place to take some profit.  Support lines are there as well for a good reason - good place to buy and take your chances.

The one thing you can't do is just ignore all the technicals and blindly assume your stock will bounce back because it "has to."  Have a plan and stick with it.  Once your carefully thought out stop is hit, get out and look for another entry point or another play altogether.

One more thing to consider is that your stop depends on your entry.  Someone else, entering 3% lower than you, could have a totally different stop (of course, key support levels apply to everyone equally, so their stops might be in the same general area as yours).  If you keep adjusting your stop lower based on market action, you might as well not have one.  Let your stop hit, and re-assess.  Someone who entered lower than you may also have their lower stop hit, but anything can happen.  The only time to adjust your stop due to market action is when you adjust it higher, to lock in profits or minimize losses, which is a prudent thing to do.  Adjusting it lower for any reason is dangerous.

Remember, you are the one who has to do whatever is best to protect yourself.  Nobody is responsible for your losses but you, any more than you want to give someone else all of your profits.  Taking responsibility is the first step to becoming a good trader.

It is easy to get and stay "lucky" in a Bull market.  Every dip is bought, and the dips are shallow and easy on the nerves.  At some point, though, that always - and I do mean always - ends.  There will be a sharp decline, followed immediately by an even bigger one.  Don't always trust in the Trading Gods to bail you out.  It only takes one time when you left yourself too exposed to get in serious trouble.  Take your loss and then sit and watch for a while.  And take profits, too, letting a winning position stay open without a solid reason for doing so also invites disaster.

Despite all the media blather about how "lucky" small traders are to be nimble, have few rules imposed on them, and so on and so forth, I believe that the deck still is stacked against small traders like us.  We don't have fancy computers in the building next to the exchanges, we don't have robots trading for us that scalp endlessly all day long against our clients' positions to make us a steady income, there isn't a huge pile of cash backing us up to bail us out of most of our mistakes.  Anything we can do to even the balance is a good thing.

Good luck to everybody, this is all about helping hard-working traders like you make their decisions and earn your bread.

No comments:

Post a Comment