I had some readers tear me a new one over my post yesterday about stops and technical analysis. There were also some comments that generally agreed with my thoughts and even a comment that is either calling me a proselytizing fanatic or calling one of the dissenting commenters a proselytizing fanatic. I apologize for not knowing.
First things first, my feelings will never be hurt by any comment left on this site. For reference, I played a lot of high school sports, was in a fraternity in college, worked on a trading floor for close to a decade and am now a firefighter. My skin is thick enough to handle a little criticism about investment strategy.
That being said and out of the way, as it says toward the top of this page, the point here is to share process and it is perfectly OK disagree with everything I write here, especially if it helps you become a better investor.
A couple of comments, if I read them correctly, seemed to think it was particularly moronic not use stop orders universally. One problem with stop orders is that some stocks gap down much lower than the stop price. Last fall I wrote about selling Google. This stock is a perfect example. Would you be shocked if on any day the stock opened $30 lower? What if you bought the stock at $420? The stock is now at about $405, down 3.5%. Your 8% stop order would be in at $386.
Back to the potential for a down $30 open. You are stopped out at $375 with a $386 stop. Would you cancel it before it executed? What if it then went lower? Would you let the stop execute, what if that was the low. These points don't make stop orders bad, they are simply some of the flaws with this particular exit strategy.
I am a big believer in having some sort of exit strategy be it with a stock or the entire portfolio but keep in mind they all have flaws. This does not seem to be that bold of a statement yet some of the commenters seemed quite ticked with me.
One reader left a comment about using mental stops. Great, its an exit strategy but with strengths and weaknesses like every other exit strategy. The biggest weakness, and this will not apply to everyone, would be that the mental stop is triggered (elected in trader parlance) but the investor does not sell. Again that will not apply to everyone.
Lastly on this topic was a comment from long time reader, George, who noted that specialists (he may have also been thinking market makers too) have been known to monkey around with stock prices to take out some stop orders. I have no direct knowledge of such things but I have seen peculiar trading in stocks that might make you wonder if this could ever be the case.
With regard to technical analysis I believe in it and use it but it is not the be all end all. If you get ten technicians to look at the same chart will all ten see the chart in the same way? Reasonably speaking, probably not.
One comment really lit into the note about Suncor being up another $2 from where someone else said was a bad entry point. This came about because I said I had no feel for whether $82 was a good entry point. Since that comment posted, the stock moved up another dollar. If the stock keeps going up, at what point will $82 have been a good entry point? I don't know the answer and I am not sure knowing matters for an investor who wants to capitalize on the oil sands theme.
For all I know the next five points may down and it may drop that entire amount in one day. I think an argument could be made for either direction and one of those arguments would be wrong.
This example does not invalidate the science. If using TA allows you to be right on 65% of your trades (for people who are traders) it might be right label that type of track record as wildly successful.
A final point would be that my exit strategy relies on the S&P 500 and its position above or below its 200 DMA. This is TA and it has flaws, like every other exit strategy. In the last couple of years there have been head fakes with this indicator. I try to mitigate this big flaw by not going 100% cash the instant SPX breaches its 200 DMA. You can check the archives for more on this.
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7 comments:
I am not a fan of stop loss orders either, but hey do take the emotion out of the decision making process so I think they may be useful for some people. Of course I think those people should be in mutual funds and not volatile stocks.
Market gyrations and market manipulation is a big reason why I do not use stop orders. I know lots of people say the market can not be manipulated but I view it like surfing. You can not control the ocean but a good surfer sure can manipulate a board on the waves. Similarly I believe their is a lot of market manipulation you can never prove. If you stay out of some ridiculously over hyped stocks and do not get stopped out these manipulations work them selves out and will not really affect you. In fact many times it will be the manipulators being wiped out not the investors.
Of course if you like playing overly hyped stocks or want to take emotion out of the decision making process go ahead and use stops. But sometimes you will needlessly take a loss.
KL
Richard Russell mentioned Suncor in his daily update last week when SU was at 82. The next day SU was up, and though not on big volume it was up nonetheless. Like Buffett, R. Russell has reached a following on par with Buffett and his words have moved markets, and stocks.
Your sell discipline should be consistent with your process and strategy. If you are a day trader, you probably need stop orders. If you are a buy and hold, then stop orders are a mechanical process that allows you to be lazy on the research.
Roger,
I buy and hold and also trade for intermediate time frames when a stock makes a drastic move quickly. I weigh the annualized return versus the risk and if it is above my expectations, I may sell partial or sell all. I always like to say "anything can happen to any investment." See CSCO, IBM, AT & T (the original one). I think it is prudent to assume there are players that know things we do not and that prices can move to the downside a long way. One way to combat that in my business is to put in stop orders based on TA and if I am stopped out, I see it as my reminder to :reevaluate" my thinking, position size, emotions, etc. Again I favor trailing stops on software or Broker/Dealer backend.
Very good discussion. A lot of people who decide to be "traders" then start putting stops loss orders in ( mental or real ).But, the mind games that are going on in short term trading are big. The big boys will sell down a stock just to trigger all the little peoples stop loss order. While everyone's getting out, they are buying. So, each time your stop target gets hit, you have to ask, " are they trying to shake me out or is it really going alot lower?" Sometimes you are right, sometimes you are not.
But, as I said before, the kind Roger impliments will keep you IN the market for the big move, but get you out before the big fall. This is where the serious money is made, folks.
g
I do not know who g is but I think more people should follow his advice
KL
One thing I absolutely despise is mindless triggering. Haven't we learned form the 87's "Black Monday"? In my theory, it is also because of these mindless selling that we have this thing called "dead cat bounce".
Also, I think Roger is confusing two subjects together. While some people are talking about exit stradegy for a single stock, Roger was, by the last paragraph of his post, talking about exit stradegy of an entire portfolio.
For a value investor, like myself, the market is sort of irrelevant. If the overall condition is bad, you'll see a scarcity in number of bargin you can find in the equity market. Naturally, you will seek other opportunities for superior return. As for exit points, my experience has been that, depends on what the new information that caused the drop is about. If it fundamentally alters the value of the company, then a sell is in immediately. Otherwise, the sell off is an excellent time to accumulate more.
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