Should You Use Mental Or Hard Stops? Here’s Your Answer…
One question I often hear traders
discuss is, “Should I use mental stops or actually enter the stop with my
broker (hard stops)?â€
The answer to this question can differ, based on your
trading style and time frame. For
instance, for someone who follows Dave Floyd’s techniques, is in and out of
stocks within minutes and might do 100 trades a day, entering actual stop orders
may not be practical. An
intermediate-term trader, on the other hand, should be using hard stops.
Most intermediate-term traders don’t sit in front of
their screens all day and babysit their trades. That’s
fine. If you’re not ready to act
immediately, or have trouble pulling the trigger when one of your favorite
stocks starts to tank, then you must have hard stops in place.
Let’s take a look at a recent leading stock to see why
this is so important. (Name withheld
until end of article.) This stock has
been one of the best acting stocks over the last few years, as evidenced by its
steady climb on the weekly chart.
Â
Looking at a daily chart (as it looked last week), traders
who held this stock may have used the 50-day moving average, around $19, or the
recent spike low, around $18, as reasonable stop levels.
Since the stock had closed the day before at $20.43, the chance of being
stopped out at either level seemed somewhat small.
Â
Now let’s walk through the mistakes of Mr. Mental who
doesn’t use hard stops. He uses mental
stops. He also likes to get good fills on
his trades and hates getting wiggled out of positions and then sees them go
higher. The following charts will show
you how Mr. Mental’s afternoon went last Thursday…
As you can see, Mr. Mental is now exactly that…mental.
Even with a lousy fill near his $18.00 stop, he would have gotten out at
$17.50. Now his brain and account are
fried. The price did bounce eventually,
but the highest it got that day was about $16.50, and the highest it’s gotten
since is $17.33. W-Holding Company (WHI)
is the stock.Â
Moral of the story…if possible, use hard stops.
If you use mental stops, make sure you take your stop every time.
Don’t cheat. You might end up
mental if you do.
Marketwise, it was a bad day for longs today.
Let’s not become Chicken Little* just yet, though.
If we get a few more days like this, I will definitely be concerned.
Let’s see how the market acts over the next few days, and then we might
be able to start determining whether today was just a blip, or whether it is a
harbinger of things to come.
Best of luck with your trading,
Rob
*The sky is falling! The
sky is falling!