Strategies for Trading Stops

Introduction

Ever wonder what day traders do when they go on vacation? Do they dial into their net every hour with their laptop to check their trades? Do they call their on-line broker’s telephone response service? Nope, they have a great time and enjoy themselves. By definition, day traders clear out their stock positions by the end of each trading day. However, sometimes they also hold onto some good long term positions.

Developing A Strategy with Trading Stops

Even day traders have a few favorite stocks that they know will increase in value over the long term. However, because the market can be so volatile they want to make sure that they don’t lose the profits that they’ve already gained. Especially if they go on vacation or are even going to be out for part of a trading day.

A good way to illustrate this is to use a hypothetical situation. Let’s say you buy 100 shares of the stock XYZ at $20 per share and by the end of the trading day it has increased to $23 per share. That’s $300 profit so far. However, you know that it has more potential because you’ve seen some very positive news reports plus the company has just released a good earnings report. Your extensive research (due diligence) has shown that the company has a good growth future, but, you also know that the price could fall just as fast if a lot of other shareholders decided to sell their shares to take their profits.

The questions to ask yourself now are how high will the price go and how low will it swing. By now you should have been watching XYZ’s Intraday chart and determined how low it has been dipping throughout the day. As an example let’s say it’s low dip was ¼ point. At 100 shares that’s $25. Also, you should have been watching the news reports, the volume of shares, checked out the chat rooms to see how popular everyone else thinks it is, and looked at it’s historical chart. Check to see if the stock looks like it could have any potential weakness such as marginal financial information like a poor production report or a poor profit projection report, short selling, or even late breaking negative news. At this point you need to decide if you’re going to sell now and take the profit or hold for another day.

The question now is: “How do you protect the gains that you’ve already made?” This is done using a Stop Limit Order, sometimes refereed to as a Profit Stop. As the price increases you enter a Stop Limit Order below the current price of the stock. If the stock has been dipping ¼ point all day you might want to enter a Sell Stop Limit order at $21 ½ so that if the price drops, sharply and unexpectedly while you’re away, your shares will sell at $21 ½. The amount of difference between your Sell Stop Limit Order and the current price of the stock is a personal judgment call on your part. You just have to watch the Intraday activity and then make your decision.

Often, when the market turns extremely volatile a Sell Stop Limit Order is most advisable on all of your positions. On the other hand, if the price continues to climb you need to periodically enter a change order to increase your Sell Stop Limit position. This is known as setting your Trailing Stops. You trail the price of the stock with your Sell Stop Limit Order as it’s price increases. Yes, you may not make that extra ½ point or more on the sale but, you won’t lose all of your profits if the price drops sharply below your purchase price. Remember, don’t be greedy. Take what profits you can and move on to the next play.

Also, if you are entering your Sell Stop Limit Order at the end of the market day enter your order as a GTC type (Good Till Canceled) so that it will remain in effect overnight and be good the next day when the market opens. If there is any adverse news or if short sellers decide to hit at the market open, the price could drop unexpectedly. If the price drops and your Sell Stop Limit Order is executed and the price of the stock starts to go up later you can buy back into the stock at a lower price.

Currently, in most cases, for most brokers, a GTC order made during normal market hours does not carry over to the after-hours trading market. Also, a GTC in the NYSE is executed slightly differently than a GTC on the NASD market. You need to learn how each market and each trading session works along with their rules in order to get the most out of your trading day.

Ok, I know that some trading systems don’t have a Stop Limit Order function. Should this be the case, set your alerts to let you know when the price of the stock drops to your lower limit so that you can be alerted in case you’re not paying attention to that stock at that time. Overall, traders without the Stop Limit Order function must develop other strategies if they are going to be away from their systems for extended periods of time.

On the other hand, those of us that do have the Sell Stop Limit functions always rest a lot easier when on vacation. So, as I sit, here on the porch overlooking the beach and surf, I know I don’t have to rush back into the house to look at my computer every few minutes.