Sunday, July 29, 2012

Honoring Stops or Not on GAP DOWN day ?

Last week was one of the worst trading week and the best trading week too.
I had got into leveraged ETFs on Friday afternoon. My thesis last Friday was that market was testing the 1360 areas from where it broke out and would bounce back to make news recent highs in 1 -2 -3 type of a move. 
But Markets had  a very extreme different view than mine. Instead of bouncing on Monday, I was looking at the futures market on Monday early morning were the futures had gapped down to 1340 areas and then as soon a the cash session opened it tanked further down to 1330 areas. 
This caused violation of my stops on my ETFs, the question was do you really honor your stops at the open or do you wait for a bounce to sell. (#2 would below would provide a decent answer to this)
We have always been taught the taking losses is a hallmark of a good trader. But when the losses are huge, you are looking at real money losses as well as huge loss of emotional capital /strength too. Honoring your stops sounds easy when you’re dealing with hypotheticals, but when real money is on the line, it’s rarely as simple as selling off shares once they open at levels way below your stop levels.  
Today, I want to explain the mechanics behind why stops work – and show how to make sure that you’re not leaving money on the table when you get stopped out.
A stop loss order is a way of protecting your capital when the market moves against you. It’s an order that triggers when the stock price fall below a specific price By putting stops in place, you’re essentially trying to lock in the maximum loss you’re willing to take on a position and bail out. 
It’s important to remember that, for traders, stops aren’t about throwing the towel and blaming the losses on someone else but it is about protecting from further losses and emotional capital.
Most of the experienced traders always have a failure rate built into their trading systems – they know that even in a perfect world, a given percentage of trades will not go as planned. That’s the key differentiation I’ve noticed between aspiring traders and trading pros.
The pros tries to keep the distance between buy price and stop price as minimum as possible. 
Once we realize this basic difference, the mental side of honoring stops becomes much less daunting. 
Understanding the virtues of being a good loser is only half of the equation.  The other half is knowing where to place your stops.
These three factors should always be in mind when deciding a stop, and you’re much more likely to find success even when markets behave like they have in last week. …
1. Stops Should be Technically Relevant
Stop loss levels shouldn’t be arbitrary – just because you’re willing to lose a maximum of 2% on a ETF doesn’t mean that a 2% stop loss is a good idea. The stop should be at a technical level.  I use the this 2%  max loss  and the the stop price I decide to come up with the position size. This way I can keep the position size in control if the stops are wide. 
Usually you will see that stocks come all the way down to support level and then bounce back hard.
In practice, stops should be placed right under important support levels. That way, once buying support has failed for your setup, you’re automatically out of the trade. Keep in mind that the support level you choose can coincide with a maximum risk you’re willing to take; technically relevant support is just the more important of the two.
2. Stop Outs Should Be Material
All too often, we see cases that  that we do a a good job of honoring the stops (and closing their positions), only to leave money on the table when the trade rebounds. This happens all the time and happened this week also.  The problem is that we are being too strict with our stops. 
To combat that, I recommend avoiding hard stops  till day's end (i.e. stops placed with your broker, that trigger automatically). When possible, you should be watching the near-term price action of the ETF you’re trading. The most important thing is monitoring the intra-day lows.   Lot of times your will see that the prices go down for couple of ticks below to support to flush out  stops  and then reverse back.
The other way to play this type of shake out is to place a hard stop at that level and then after a sell order is triggered, put a buy stop order couple ticks higher than your stops. This will bring you back in the same position that you were flushed out of.  This requires One triggers other (OTO) type of order.  New brokers offer this but lot of old brokerages does not offer this type of a feature.


If your ETF gets stopped out at open on a gap down day. Honor that stop, you will be saved from further pain if the market gets flushed more. If you are stopped out then put a buy stop order to buy back in your position if the market decides to come back up after flushing the stops.
3.  Accountable Stops / Portfolio Performance.
If you’re having trouble pulling the trigger when it’s time to sell a stop out, you need to be accountable to your stop loss orders. One of the easiest ways to do that is to be explicit about them: consider posting your trading levels on a public forum like a blog or Twitter. A more private and handy solution is to keep a trading journal that clearly defines your stop loss price for any stock. This requires you to review your trades that fell below those levels.
There’s no question that taking a loss is the trickiest part of being a trader – but in my experience, it’s also the common thread between the most successful traders I know.
Master the art and science of stop and you’re well on your way to protect your substantial emotional as well as money capital in any type of  market.



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