Thursday, December 8, 2011
I like Stop Losses, I just don't normally use them - Hard Stop Losses, that is. A Hard Stop Loss specifies that we want to sell when the price drops to, or below, the Stop Price we have entered. This is so we can specify the selling price in advance, which means we don't have to sit and watch in case the price drops below that point.
Stop Loss, or Target?
While it sounds good in principle, my experience is Hard Stop's don't work so well. The main reason being, if the market maker for the equity I own sees the opportunity to make a large commission by tripping my Stop Loss, that is usually just what happens. In today's world, I don't know exactly how the orders are matched, but it has been my experience that the person responsible could usually make it to my stop to collect the commission, only for the price to continue higher from there. I suspect it is even easier to do in today's electronic markets. If the Stop Loss is too far away from the current price, they won't even allow it. If it is fairly tight, or close to the price I want, then getting to that price is doable.
Don't get me wrong, though - I am one to say never enter a position without having an exit point. If I am unable to watch the market during the day, then I wait until the end of the day to put in the sell order, if necessary. If I am in doubt as to how far the market might move against me, I just sell, anyway.
I don't use Hard Stops and I don't use Trailing Stops. These are Stops that trail the price by a given amount, or percentage. Instead, I use trend-lines and technical analysis to determine my exit point. When the price is trending, we can usually draw a channel within which the price will vary. As long as the price stays within the channel, I continue to hold. Once the price violates the channel, and breaks the trend, it is time to sell. Once the new trend establishes itself, I take a new position.
Stop and Pause
Rarely is it a good thing to exit a trend and switch to the new one at the same time. I learned a long time ago from sailing that when the wind begins to shift it will oscillate back and forth a few times before filling in from the predominate side. The markets are similar. You don't know which side the strong hands and the weaker hands are taking at first. We want to do what the big guys are doing because that gives us the greatest probability of success. Getting it wrong can get expensive.
Getting stopped out at the lowest price for the day is never a fun thing. Instead, I use limit orders which specify the least I will accept when it is time to exit. Do you use Stop Losses?