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Saturday, June 11, 2005

Stop Loss Q&A

There is a Stop Loss Q&A article on Hard Right Edge site. They point out some common mistakes a lot of traders do when they set stops.

Trading Tactics
Stop Loss Q&A
Hard Right Edge

Over time, carefully chosen exits are more important than great entries. You don't believe me? Just ask all those folks who bought tech stocks in the late 1990s.

If a stock is set to gap through your stop loss when it opens, do you sell it immediately or wait for a bounce? There's really no right answer. I usually pull my stop and watch the first few minutes of trading. If the market reverses, I try to close out on the bounce to a common retracement level.

Some midday panic situations are global, while others are sudden. Most times, my preferred fire drill is to exit first and ask questions later. Sometimes I'll see the futures go crazy and not know why. They may not affect my individual positions at the time, but I'll often exit everything until I can find out what happened. I still remember the futures going crazy on Sept. 11, 2001. There was only a few minutes to jump ship before the market was shut down for days.

But the nature of price mechanics suggests that after an initial rally, a stock will pull back to test the original breakout level. Train yourself to avoid breakout entries and instead trade pullback entries.

Q: Should I lift my stop-loss when I know the stock will gap against my position when it opens?
A: When there's news that could affect the stock, I pull the stop loss and keep the position through the open. Then I try to hold for the first 10 to 15 minutes to see if it reverses or runs. If the stock starts to run or breaks a large support-resistance level, I get out immediately. The strategy can lead to a larger loss, but it's a tradeoff, because the gap prints the high or low for the day more than 70% of the time.

Get more aggressive as the stock approaches your reward target. Shift your strategy after the price passes 75% of the distance between your entry and intended exit. At that point, there's no sense risking a bundle in order to make a few pennies. Move the stop in close so any small reversal takes you out of the trade.

Stop-running or stop-gunning (both terms are used) occurs when a price is pushed through support or resistance in order to trigger the stops that are hiding there. After the stop supply is exhausted, the market bounces back in the other direction, usually winding up where it was before the exercise began.

I never use a stop limit on anything. It's too easy for the stock to go right through your price, not get filled, and trigger a deeper loss. When you want out, you want out.
Read further:
Hard Right Edge: Trading Tactics: Stop Loss Q&A


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