us stock market, trend trading stock

Since we never know the ultimate results of the trade until it is closed and since we want to cut losses rationally, it is important to have an exit in place. One way to attempt to remove the emotion from trading and establish an exit in the event a play goes against us is to place a stop loss order. Most brokers do not charge for placing a stop loss order or changing the stop loss order until it is actually executed. Always check with your own broker to be sure. A stop loss order is simply an order to our broker to close the position in the event a specific price that we define is hit. For example, suppose we buy 500 shares of XYZ stock at $35.20 as it bounces off a support at $35. In that case, we may place an order with our broker to sell the stock in the event it hits $34.98. That type of order would be known as a sell stop. Once the stock dropped to $34.98, our order would go to the floor as a market order to sell. That does not mean that we would necessarily get $34.98. By the time our order actually gets to the floor, the stock may have dropped more and we could get filled in at some lesser amount. The point is we would be out of a stock that has demonstrated that it is going in the wrong direction. Similarly, if the stock turned back up, we may get more than the $34.98 but we would be sold out of our position. These stop loss orders can be extremely valuable, particularly if we cannot be watching a stock all the time. If I am traveling, or for some other reason, and not able to look at the market, I invariably place stop loss orders so that my positions are closed if they go against me.

One of the problems with a stop loss order is that it may be visible to the market makers. There are times, it seems, when a stock will dip down, take out a lot of stops, and then turn right back up. That is a risk that a trader must take if he chooses to place a stop loss order. Another method that might be utilized is to place an alert so that the trader is advised via e-mail, cell phone, or pop up on a chart when a certain price has been hit. When an alert is used, further action is required by the trader. He must then place the order to sell the stock in order to extricate himself from the position. One must be disciplined to respond to the alert and not decide to just let it go a little bit further. The idea that "it's coming back" can be quite expensive.

One of the methods I frequently use once a stock has reached a profitable area is to place a trailing stop loss order based on a percentage of the stock price. For example, let's say I bought a stock for $40 and it is now trading for $50. I may place a trailing 3% stop loss which automatically adjusts as the stock price increases. If I placed the order when the stock was at $50, I would only be sold if the stock retreated 3% or was it down to $1.50 from $50. Let's saying the stock continued on to $60. Now, my position would only be sold if the stock was down 3% from the $60 mark (would be sold when it was down $1.80 from $60 or at $58.20). A trailing stop loss order gives the stock some breathing room but automatically takes the trader out in the event it dips some predetermined amount from a high. I really like the trailing stop loss order, but use it only after I am in a profitable position.

I should also mention the stop limit order which I never use as an exit. Many times new traders are confused between a stop loss and a stop limit order. I have already described the stop loss order which is an order that simply instructs the broker to act at the market once the stop number is hit. The stop limit order, on the other hand is actually two orders. The first part of the order is the stop and when that is hit, instead of sending the order to the floor as a market order, it sends the order to the floor as a limit order. Let's say that I would like to exit a position if the stock hits $40, but I would like to get at least $39.50. I could place a stop limit order with a stop at $40 and a limit of $39.50. The problem arises if the $40 is hit but the stock then, for example, gaps down to $35. My stop would be hit, but since my limit could not be filled I would still be in the position of holding a stock as it continues to drop dramatically. For that reason, I avoid the stop limit order when setting sell exits. If the stock is moving against me, I just want to be out of the position once the stop loss is hit.

The stop limit order does have value when it is a buy stop. Suppose I am interested in entering a position in a stock once it goes up above $40, but I do not want to pay more than $40.50. In that case, I might well enter a stop limit order where the stock portion of the order is $40 and the limit portion is $40.50. In that way, once the stock hit 40, I would have automatically entered a buy order with a limit of $40.50. If the stock suddenly soared, I would not run the risk of entering a position at $50 or $60 when I was really expecting to pay no more than $40.50.

Good Trading!
Bill Kraft

Mr. Kraft's past articles are posted on our website for your review.

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