Exit the trade if you risk losing too much of your profit
These exits are often referred to as a trailing stops. The trailing stop can
be implemented in many ways, but there are some common themes:
- Exit when the price is below a certain percentage of the highest price after you bought the stock (the highest price defines your maximum possible profit so far)
- Exit when the price is below a certain limit defined by how volatile the stock is (basing the exit on how likely the stock is to get that low without the price trending down)
The trailing stops endangers lowering your maximum profit
The more frequently the trailing stops are triggered, the less likely you are to get the
really high profits. Thus, you need to set the trailing stop so far from the normal trading
price thatit is triggered only when it seems likely that you will lose
profit from keeping the stock.
This also means that if the stock is volatile
(big swings in the price), and you use percentage based trailing stops, then you should allow for
high percentage swings so they allow for the probable fluctuations in price and do not stop you
out of the action too early.
The high volatility stocks will have you risk more money than low volatility stocks
Your volatility based stops should allow for the normal
swings in the price, but the allowance for wide swings also makes you more
vulnerable for profit losses when the price turns down. It will take more price
movement before the down move is considered outside "normal trading
activity".
Thus, with a volatility based stop you will risk more money
before being stopped out of the deal. This means that if you do not want to risk
too much money, avoid trading the really volatile stocks.
Deciding if a stock is too volatile for you
There are many ways to do this. One way is to define how much you are willing
to risk as a percentage, and then plot the thus defined trailing stop limit in a
chart. Then, plot a volatility based stop in the same chart. If the volatility
based chart is inside the percentage based stop, you can trade the stock, and if
it is outside the percentage based stop, you will need to risk more money than
you are willing to trade that stock, so you better find another stock to trade.
If
you have Supercharts, there is an easy Language function available that allows
you to easily compare
percentage based and volatility based trailing stop levels.
Headlines
Never trade stocks without having tested your system. In fact, most trading systems are not profitable if tested over many stocks. Full story...
Do not invest in heating equipment without having compared the alternatives, not only to current situation, but also to each other. Full story...
View Mats Bengtsson Home feed in reader
