Feb

The "News Slam" – Poker Bluff – Stop-Loss on A Stock Trade

When you sit down to play poker with 4 of your buddies you don’t expect to win every hand. That’s quite obvious and everyone would agree that if you do expect to win every hand you are in for a rude awakening. As a matter of fact you have exactly a 20% chance of winning any given hand. Not great odds, yet but a couple good hands is where all the money is made. The trick is "folding" and losing your ante when the hand you are dealt sucks, rather than betting along and staying in seeing raises when someone obviously has better cards than you .

That’s a simple analogy of why we use stop-loss orders on all trades. You have to cut losses quickly so the losers inflict as minimal damage as possible on your bankroll. So with trading we have to decide what is an acceptable loss on any one trade knowing full well that a stock has a 50/50 change of rising or falling from our entry price. Entering trades on a move to the upside and on a white candle helps improve our odds, but to be successful in the long run we must quickly cut losses so we can anticipate the next trade, bankroll mostly intact. Any seasoned trader can rattle off trades that were stopped out and shortly thereafter either turned right back around and went straight up or fell off a cliff. But the great thing about stops is that you remove the possibility of a catastrophic loss on any one trade.

With that said, in this environment (bear market) we are subject to getting bluffed out of what might to have turned out to be a good hand/trade. In the case below our system identified a potential breakout in MRO and then the news-slam took out our stop. That’s ok because there was potential quicksand right below the stop. We will look at screenshot of the original trade then a couple charts of the stock from different angles.

In a larger perspective it seems we might have been bluffed out and wish to revisit and perhaps revise the logic involved in creating this stop. In this case the system recognized the congestion level and prior lows before the break-out entry and and assumed setting the stop just under the pivot would be adequate. Obviously this was not the case. When we zoom out a bit it seems as if the stop might have just been a tad too tight.

I wanted to revisit this particular "trade gone awry" at the end of the week to see what happened after the stop was hit. I also wanted to document the chart so we can come back in the future and see what we learn from the experience. Generally a "lower low" is good enough reason to cut the trade and run, however only time will tell if we were "bluffed-out" or if the difference between a 6% and a 7% stop if the difference between good and evil. This last chart is where we are today.

Better to err on the side of caution and ask questions later. It’s tempting to consider adjusting the logic for stops to give them a little more leeway, but sometimes you just play the cards you are dealt. It’s still early in the game.