My take on stops, given my trading style

Hi all,

Everyone has different trading styles. I am now realizing that what works best for me and my personality is dip buying, once some suggestion of support has been found (and PPT Hybrid flagging oversold is a very strong such suggestion, even in the absence of price action to support such a claim – if you’re not a member of PPT yet, you’re missing out, especially since we seem to be back in a market which doesn’t just go straight up).

As such, I don’t have really have fixed percentage stops in mind. I know that a 7-8% stop  is a pretty standard line in the sand for people, but I would never use it. Why not? Because I would never buy something 7-8% from its recent support (not anymore, at least!). To me, buying a stock and throwing an 8% stop on it means that either the  buy is based on fundamentals (i.e. you believe the stock SHOULD go up, just because it’s a good company, or you feel the selloff is overdone (can anyone say $GS!?!? 🙂 )), or is  a random dart throw – buy a stock, give it an 8% stop, and see what happens. Or, perhaps, you’re chasing it, and it’s that far away from support by the time you buy it.

I do not mean to put down any of these styles, I am simply saying this is not me.

I do not need to see evidence of the stock breaking up, before I buy. I operate on the assumption that, everything else being equal, after a selloff and a period of consolidation, the price will want to, by default move up, as dip buyers come in.  I just need to see something which suggests to me that the stock has stopped its slide. Nothing is for sure, no signal means “yes, DEFINITELY” the slide has stopped, trading is always (ALWAYS) a game of probabilities. As long as you have a “system” which lets you have more winners than losers, you’re laughing.  This is my system.

I’m doing to demonstrate using a 1min chart of TNA, HOWEVER please note that this approach would be valid (IMO) on all time frames – those bars could be hour, day, week, or month periods, and the idea would still be the same. I simply don’t have the personality or the patience to wait days/weeks for a trade to confirm/deny my theory, so day trading, or couple day swing trading is mostly what I do (this is why I failed to take full advantage of the Sept->Feb run, I was taking profits along the way, I did not just let my TNA and FAS positions run, so I booked great profit, but not egregious:) ).

(I apologize for the chart being somewhat busy, I guess I’m trying to demonstrate a few concepts here: stops, entry points, problems with chasing, and bailing out on poor entries if given a second chance).

Note that there are other styles of day trading/scalping something like TNA, where you almost anticipate that a particular point will act as support, and make a buy, with a very short stop on it – there is merit in that approach, but it’s beyond the scope of this blog entry, so I will not discuss it here.

The notes on the above chart are pretty self-explanatory, let me just point out that situation (g) was discussed (as a multi-day time frame, but the idea is the same here) in my previous blog post: http://ibankcoin.com/king_of_the_pg/2011/05/20/if-you-can-sell-a-bad-entry-trade-do-it-dont-think-about-how-much-you-could-have-made/ ; even if the the recovery did not bring you up to exact even, once it stalls again, most definitely put a stop under the most recent lows, to minimize your downside, should the price resume its downward slide.

Here’s my rant against chasing, again. Consider (d), and the dashed resistance line. You would be foolish to buy below that line, because that point has proven to be resistance in the past, so no reason to assume that it won’t act as such again, BUT if you wait until price breaks above it, you are very far away from any reasonable stop, and risking a LOT without having any idea of the upside. In the case of (d) there was quite a bit of upside, but in the case of (f), not so much – chasing after this price action in (f), above the resistance, was an excellent way of top ticking the buy, and finding yourself trapped for the rest of the session.   If you want to participate in  stock’s meteoric rise, wait for a pullback and consolidation. Yes, you’ll miss out on some profit, but you’ll miss out on losses too.

One final note about stops: when placing a stop under previous support, do not place it too close to that past support! I have seen, countless times, this situation (here I’m talking about stocks on daily charts, not min bar day trading): price approaches past support, goes under it by a hair, then suddenly jumps down more, stop, hovers, starts to recover, and shoots back up.  This is my theory of why that happens:  shorts automatically jump in few cents  below previous support – that rush of selling, in anticipation of a further slide, pushes the price down suddenly, while dip buyers are waiting to see what happens.. When the short orders are filled, there is a pause. If there is no clear evidence of further selling strength there, dip buyers will come in, and start to push the price up.. At some point, the now-trapped shorts will bail, buying back the stock, pushing the price even further up, which, to other dip buyers looks like the price found support and is recovering, which caused them to jump in, etc, etc, etc – and the stock recovers, having found new support, under old support.   This is why having a stop a hair under old support/low is a wonderful way of getting yourself stopped out on the bottom tick (and yes, I AM most definitely speaking from repeated personal experience).

Hope you’re all having a great weekend!

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