Wednesday, September 22, 2010

On Setting Stops

One of the most difficult aspects of trading in my opinion is deciding where to put my stop. I realize it is a fool's game to try find a perfect stop -- there will always be situations where the stop looks dumb in retrospect. I think the most valuable aspect of pre-determined exit points is that it takes the emotion out of the trade.
"Even more frustrating when your stop is hit, then the trade immediately turns around and hits your profit target - and more! We've all been there. Forget about it."
 -  @chicagosean  
Nevertheless there is value in reviewing stops to see how they worked or didn't work. What I want to focus on here is whether to exit when any intra-day tick reaches your exit price, or whether to wait for a close below the price.

Last week I was stopped out of NRGP when it dropped below my 7-ATR trailing stop (orange line at $27.00) and the bottom of the Darvas box. It then went on to close above my exit price and has gone back up to the 50-day moving average.

This week Edwards Lifesciences (EW) has done the same thing, except this time I had decided to wait for a close below the 7-ATR trailing stop. As you can see it rallied strongly and is now above the 50-day SMA again (purple line). The increased volatility is a message in itself: something is causing uncertainty about this stock. That something is the unveiling of news about the company's heart valves (on Thursday I think) which might set EW on pace for a buyout or send the stock plummeting. One approach would be to sell half of the position ahead of the news.


Here's the 10-minute timeframe view of EW as it touched my trailing stop. It didn't close a 10-minute candle below 53.31, and when it dipped down there it was very oversold.


As I said before it is futile to try to over-optimize a system. But I think waiting for a close below one's exit price is something worth considering. The flash-crash of May 6th is another reason to consider this. Either way, the approach should be systematic not emotional.


For more, check out some of the quotes and links from Chris Perruna in this post: How I Use the All-Time High Lists (19-Sep-2010).

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