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Market Lab Report
A question on selling

Q: Your site and recent book have been very helpful to me in learning some basic trading philosophy and techniques. O'Niel's "How to..." is next on my list. One issue, however, I can't get a clear feel for is how to set stops. I understand some of the ideas about stocks "obeying" moving averages and a couple of the rules you put forth in the recent book, but I am unclear on the more basic element of whether you actually trade with a trailing stop, a regular stop, or a mental stop. I have heard several perspectives and theories. Some say don't enter physical stops because the "machines" will see it and grab my 100 shares (it does feel like this has happened a couple times, believe it or not). On the other hand, other people seem to use mental stops, but what do you do when your stocks get hit by an SEC notice to audit (GMCR) or your oil platform explodes (BP).....the equity is already shot before the mental stop can be used? Other times, I have been stopped out, only to see a big move the next day. I would sincerely appreciate any insight or resources you could provide as I can't resolve the conflicting opinions I have found.


A: We use mental stops. We trail the mental stop as the stock moves higher using moving averages such as the 10dma and 50dma which we discuss at length in our book. Physical stops can end up being artifically triggered so they are not as ideal as mental stops, though are still effective as they usually wont get artificially triggered.

In the case of a gap down due to surprise news, the stock usually gives warning signals in its price/volume action in the days or weeks leading up to the gap down. This explains why neither Gil nor I have been caught in serious gap downs in stocks more than a couple of times in our trading careers which span nearly two decades.

If you do get caught in a serious gap down, sell the stock. In subsequent days, you can redeploy your capital into a stock that signals a buy that will clearly be healthier than a stock that has gapped down.

The risk of a stock gapping downs is one reason why you might want to build a position in a stock more slowly. As your profit in a stock grows, you can add to the position by way of pocket pivot buy points.

When you get stopped out, should the stock turn back up and move higher, that's trading life. Expect it to happen. But if your sell rules are sound, over time, your sell stops will save you more money, and the stocks that work will more than make up for the little losses you take along the way.

First published: 5 Nov 2010
Last updated: 5 Nov 2010