“The Ins and Outs of Stops” (Read this, and you’ll know how to use them correctly)
Stops – I think we fall into 2 basic categories: defining risk, and profit protection.(I’m analytic too, but I like to bring things down to as small a level as possible so that the fundamentals make such good sense that they become common sense/second nature when I go to execute the decision.)
Defining Risk
1. Buying a squeeze? Then your thesis is it’s going to pop.
a) watch it consolidate for 3 days, 3 weeks or 3 months before you decide you’re wrong. Mark your calendar to sell by a certain date if there’s no action.
b) watch it tag the lower BB before it goes up through the top (how many times have we all been faked out by a dip only to watch it run up and pop?) Then your stop needs to allow for a tag or a few cents below the lower BB.
c) if you bought because it kept closing above the middle Bollinger Band, if it starts trading below the middle BB, then your stop needs to reflect that, because your thesis is now wrong. It doesn’t mean that the stock won’t come back up and pop, but if your reason for buying has changed, and the behavior of the stock price has changed, then that needs to be respected as a new piece of data that should be considered.
d) if the expansion is starting RHRN (“Right Here, Right Now”), or just recently started , decide what you’ll tolerate in case it’s a one or two day pop only, and visualize the stock not going further, or retracing to where it is now and then consolidating. If it’s at the same price or just barely up a week from now on wider BB’s, your reason for buying no longer exists. We buy the squeeze/expansion because of the expectation of more rapid gains. If that’s not happening, unless you’ve been wanting in on this stock for a while anyway (like AAPL or ASH), then there’s no reason to hold it. Look for the tightest level of support because there’s no reward anymore. Tight tight stop so that you can free up the cash to buy something that’s become a great buy point instead.
2. Buying an existing parabolic expansion that’s gapping up? Then your thesis is the expansion is going to continue.
Buy really small and set that stop at the prior day’s low. If the prior day was a really long green candlestick, then set the stop at a little more than halfway down that candlestick. You’re buying to get in on parabolic pop. Once parabolic pop is out of the running, your reason for being there is gone too. Get out.. meaning your stop is set to reflect that the pop has run its course. That way if you buy at the top of the pop, you’re out cheap (which is why you’re buying small). Those first candlesticks can be so long that the stop you set is over 10% beneath your buy point when you get buy given a gap up. That’s BIG risk if you’re wrong, so keep the buy small so it doesn’t cost you much to be wrong, but at least you have a fair chance of making money on that if you happen to get in at the middle of the expansion.
3. Buying a stock that’s been heading down? Your thesis is the stock has bottomed.
Set your stop beneath the most recent maximum power of the bears, i.e., the most recent recent down day. For this kind of buy, ideally this candlestick should have a long tail or shadow to show that the stock went down but the bears couldn’t keep it down. That, or you have a green day with good buying action and good volume, that ideally has little or no lower shadow/tail. If the stock goes below the prior low, it shows the bears aren’t done… so the stock hasn’t bottomed. You’re wrong. That’s what happened to us on Friday. Our prior low on the SP500 didn’t hold. Buying was wrong (generally).
4. Buying a tag of support? Your thesis is the stock is bouncing up off support.
Set your stop below that support. Whether that’s an even number, a moving average, a gap, whatever, set the stop just below that, because if the stock goes lower, you’re wrong.
Profit Protection
Look at the chart of your winners. Look at those times on the chart when the stock went back down after a nice rally and envision that happening starting tomorrow. Look at how much money you made. Now imagine how you’re going to feel if there’s a regression to the mean and you lose your profits. And when you hear yourself say ‘but what if it keeps going up and I get stopped out?, then ask yourself “if I didn’t own this, is it a RHRN”? The less that it’s a RHRN, the more profits you need to protect. The other thing to think about.. what if there’s no correction, but your great stock just consolidates, and consolidates, and consolidates. Meanwhile you keep reading in the forum and hearing Dan’s videos going on about how “this one’s been great, it’s up 6% this week” or how people are finding these stocks that are popping or have bottomed, while your money is doing nothing because it’s in a favorite stock that did so well.
How are you going to feel if you lose that profit. If you set your stop and you get stopped out and the stock goes up, you did not lose money.
I’ll say it again (mostly because I need the repetition too): “You Did Not Lose Money!!“
I know it feels that way, but look at your bottom line.. the truth is that’s just emotion talking. The reality is you now have cash to find one just like you cashed in on, and can do that run all over again, perhaps even better with another stock. And, if you really did sell too soon and the fave stock is going up on volume, buy back in. If it becomes a RHRN for some reason after you sold, then buy that portion back. So what if you have a few less shares, it’s still money making more money. This is a bad thing…how?
Last point:
When you’ve made your decision to buy, you don’t buy without knowing what your stop will be, because you should not buy anything without the “what if I’m wrong” number in mind. And before you see what the stock is doing after you buy, you put in the stop order. Your only related task is to move those stops up as your stock goes up.. .and believe it or not, that’s a great feeling. Deciding on the stop price when it’s going down sucks, but when it’s going up, it’s cool, it’s self affirming, and you can sleep at night. When the market gets toppy, then see the first part on profit protection and raise those stops even more, or just reduce your position size. If I’ve got a stock that’s only gone up a few percent and less than 10%, I may just cut the position in half even if it’s just a small entry, not wanting to lose the only 3% I’ve made. It’s still better than watching it go down 4% on a bad day.
soooooooooooooo that’s my .02 on stops.
–Joanie
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