We have had a number of questions on stop losses in this market, so this seems like a good time to discuss them a bit. (August 13, 2001)
One of the problems with a stop loss in a choppy market is that the volatility intraday can take you out of a play when it then turns higher after a test lower. Of course, when you don't have a stop loss in place that intraday touch lower stays down and does not lead to a rebound. What to do?
If we are not going to be around to check on positions or at least be able to keep up with the market through a Palm or a call to the broker we will use stop losses to protect the downside. It won't save us from a disastrous drop and can actually hurt us if we have a stop loss in as a stop loss becomes a market order if the stock price gaps below our stop loss. In that situation we can be sold out on the lowest trade of the session as the stop loss order will be executed on the next trade after the stock starts trading. In that case a stop loss can hurt us more than no stop at all.
Then there is the stop limit which says I am willing to sell at X price but not lower. If the stock gaps below that point, no sale is triggered. If the stock subsequently rises to your stop limit price it will be activated. That is why we often use stop limits just below major support levels (50 day MVA, strong price support) because a stock that gaps through these levels often comes back to test them before tanking again. We don't get the worst trade, and we can get out at a better price.
While we put stop loss points on the reports at subscriber request, we do not use them in all of our positions. At least we do not always use pre-set loss points. We use mental stop loss points, i.e., knowing where we want to sell if the stock tanks on us. That way if we get an intraday test lower, we are ready to sell if we don't get a recovery, but in this market we don't necessarily pull the trigger automatically when a stock drops on light volume. At the end of the day before the close, we will look at positions. If one has tested low on high volume, has broken our stop point, and is not bouncing, we will then go ahead and get out if we see no redeeming features.
This can help us on the upside as well. We have many stocks hitting the buy point and then running up for 2 to 3 sessions, hitting or hitting close to our target price and then turning back down. We can get considerable intraday volatility even in the moves higher, but the close at the end of the session is higher. This allows us to hang in on those plays that are making the move we want even if the move is made in an up and down fashion. Then we can take 5%, 10%, 15%, whatever we are comfortable with. Using stop losses does not provide a lot of comfort in this market; we are looking a lot at 50 day MVA breaches as sell points or when a stock CLOSES below the breakout point from a pattern such as a wedge, cup with handle, double bottom, etc. If it cannot hold on the close above that point, it usually heads down further at least in the short term.
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