I may have solved my time-crunch problems, and catch this for a solution: It's 5:45 AM and I'm sitting at the pool watching the girls swim a 1600-yard warmup.
I thought swimming was competitive in Connecticut. Well, here in the Potomac Valley, it's at a whole new level. Let's just call it
. Who knows, maybe it's the political environment, or maybe it's the crab cakes. Whichever, the first swim meet the girls attended this past weekend was an eight-hour gruel-athon. And this identical meet, with kids from other parts of the metro D.C. area, was going on at two other locations at the same time!
Anyway, the girls' new swim team offers 10 different practice times a week, with three of them starting at 5:30 AM. I know, it's a killer time even to be up, but boy, it makes the after-school stuff time a lot more relaxed, and without the distractions of home (yuck, still more moving boxes), my keyboard can really buzz.
So what's going through my mind at the crack of dawn? Stops. That's right, the ultra-dull subject of stops.
First of all, I'm willing to bet many of you don't even use stops. Of any type! You just rely on "gut feel" to know when to get you out. If you're profitable year after year, then terrific -- you probably don't need to read any further.
But any kind of touchy-feely exit never works for me, because, well, I'm the ultimate rationalizer. I mean, I can defend a position while riding it down 30, 40, sometimes even 50%. No, I need a hard stop on the books.
The question, though, is what kind of hard stop? In that regard, you have basically two choices. The first is a hard stop that's placed on the books and never moved. It can be placed under previous resistance, or at a fixed dollar or percentage point. The attached chart of
shows a good place to put a resistance-based stop.
I use a stop similar to this type, and once it's set, I leave it in place until either that or my profit target is hit.
The other type of stop is the trailing stop. Initially, the stop is set as in the Microsoft example. However, as the trade moves in your favor, the stop is trailed behind it, until your profit target is hit, or the stock retraces and you are stopped out.
This technique is strongly advocated by the "letting your winners ride" crowd, and intuitively has its advantages in that you're consistently locking in gains. The trick, though: Finding a consistent methodology to figure out how to trail your stop.
There are a few choices in that area -- keeping the stop a fixed dollar amount behind the stock's price; keeping the stop a fixed percentage behind; or a method advocated by Nick Darvas in
How I made $2 Million in the Stock Market which consists of moving up your stops only after a stock retraces. The method takes a bit of explaining, and if you're interested, I strongly recommend ordering the Darvas book. For now, let me illustrate on the same Microsoft stock how the "Darvas Method" might work.
As you can see, the Darvas method, like most trailing stop methods, works great with a strongly trending stock. In the case of the MSFT example, you'd have locked in over a 20% gain.
So, trailing stops are the way to go, right? Well, maybe not. For one, the longer you hold, the more exposed you are to extraordinary gains -- and extraordinary losses. The chart of
illustrates the problem, and shows the difference between how I played CS and how someone using trailing stops might have done.
Now, could a gap down happen anytime? Of course. No matter what money management method you use, you're always susceptible to an extraordinary occurrence. However, there's no doubt that the longer you hold, the more at risk you are. It's for that reason that I am reluctant to use trailing stops.
On the other hand, there's definitely a place for them. In fact, if one took volatility into account with the Internet stocks, a small fortune could have been made using trailing stops on stuff like
. Me, I'd get 5%. Someone riding those up: more like 500%! That's certainly an argument for the trailing stop approach.
Like most issues involving money management, though, it boils down to two things: what works, and what works for you. In many tests that Wesson has done, he can find no significant advantage in any method that is better than our current fixed stop method. So much for the golden rule of "letting your winners ride." Frankly, there's no evidence other than anecdotal, that this homily is more profitable than any other solid money management method.
But, testing is one thing, and living with your method is another. Frankly, there are many traders who simply cannot stomach making only 5% on a stock when they could have made 50%. And those people probably should use trailing stops.
My best advice: Start with a method you think you can live with, and then test it enough to make it profitable. At the very minimum, even by thinking about a stop-loss strategy, you'll be way ahead of most traders who focus simply on entry.
Gary B. Smith is a freelance writer who trades for his own account from his Maryland home using technical analysis. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. TheStreet.com has a revenue-sharing relationship with Amazon.com under which it receives a portion of the revenue from Amazon purchases by customers directed there from TheStreet.com.