Monday, March 17, 2014
Last month, I received a note from a subscriber to my DailyWealth Trader service... "J.W." was confused about a position we held in double-long biotech fund BIB.
J.W. says we stopped out of the position. He says his broker sold his shares. I say we didn't stop out. I say we're up 35% since December.
Today, I'm going to address J.W.'s mistake. And I'm going to cover one of the most important lessons you'll ever learn as a trader.
Let's return to BIB...
In mid-January, BIB hit a closing high of $93.88. That set our 15% trailing stop at $79.80.
Now... take a look at the chart below. You can see the price line hasn't been below $80 since early January.
So why does J.W. think we stopped out?
The chart above is a chart of closing prices. That's what we use to trigger our stops in DailyWealth Trader. But if you take a look at the chart below, using intraday data, you can see BIB did briefly drop below $79.80 early on February 5.
J.W. had entered his stop order with his broker. So when BIB "ticked" down below that level, his broker automatically sold his shares. But it was back up over the stop by the time trading closed that day. And it's up more than 16% since J.W. stopped out.
There are two things to think about here...
First, using closing prices versus intraday prices for your stops.
In DailyWealth Trader, I almost always suggest using closing prices. They're not as volatile as intraday prices. (Using one-minute increments, BIB dropped 16% from its peak in late January to its bottom in early February. Using closing prices, it dropped only 13%.) In general, that means closing prices will be slower to trigger a stop.
Sometimes, that will hurt you. Let's say a stock "blows through" its stop with a big fall during the day. Using closing prices to trigger your stop would keep you in the trade until the next day. You could end up with a much worse exit price than if you had sold right at the stop the day before.
In an uptrend, though, using stops based on closing prices will keep you in a winning trade longer. And you won't get "whipsawed" out by extreme intraday moves.
The second thing to consider is how you track your stops...
J.W. entered his stop as an order with his broker. The benefit of that is that everything is automatic. You don't have to spend any time watching the market or executing the trade. But that's a drawback, too. If there's a "flash crash" or nonsensical price action, you can get kicked out of your trade for no reason.
Plus, our old saw is that it's like playing poker with your hand showing. It makes it very easy for other market participants to take advantage of you. That's not as much of a concern with a heavily traded stock. But in small stocks – especially in small stocks recommended to newsletter readers who are all using the same stop – it can be trouble.
That's why we prefer to set "alerts" to let us know when we've hit a stop. And there are lots of easy ways to do that...
A pen and paper, for example. I know folks who simply write a number down on a sticky note next to their computer. They check in on prices at the end of the day to see if their trades are still in good shape.
You could take that to the next level with a spreadsheet. If you're an Excel buff, you can enter in the latest prices and program your spreadsheet to calculate your stops for you.
If you're looking for a higher level of service, try your broker. Don't enter a stop order. Instead, enter an alert. You can do that without tipping your hand. On TD Ameritrade, you set alerts up on the "Trade Triggers" page. If you have trouble finding that function on your broker's website, give the customer service line a call.
One problem here is that you'll receive intraday alerts, not just alerts on closing prices. Also, you might not be able to set an alert for a percentage decline. You have to set a particular price. So you'll need to adjust your alerts as positions move higher.
You can track percentage stops with Yahoo Finance. Go to the main page and look for "My Portfolio" on the left-hand side. You'll need to sign in with a Yahoo, Facebook, or Google account. Once you're signed in, you should see a link for "Set Alerts" above the gray bar. Again, you'll receive alerts on intraday prices. And there aren't a lot of "bells and whistles." It's a bare-bones service.
If you want the "Cadillac" of alert services, take a look at our corporate affiliate TradeStops, which was founded by an S&A reader.
TradeStops Complete will use closing prices and can track trailing stops, hard stops, technical indicators, and even "cost basis" stops, like we use for our options trades in DailyWealth Trader. It'll also import your information from your online broker. It retails for $299 a year. But you can get a big discount right here. (Sign up for the standard trailing stop service, then look for an offer on TradeStops Complete.)
However you do it, the bottom line is that you have to take responsibility for setting up your alerts and implementing your stops yourself. Don't leave it up to your broker.
If you do, you could end up like J.W. – out of a trade before the gains are done.
Amber Lee Mason
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