How To Use Rolling Stops In Your Trading


The markets today (Monday) proved that we remain in a highly volatile,

news-driven environment.  Pretty much the only news that has mattered to Wall
Street lately is war news. If the perception is that things are going well, we
rally. If the perception is that things are going poorly, we sell off.  Unless
your strategies are based on trading volatility, rather than direction, I would
encourage reduced position size, at least for positions held overnight.

Notable on the chart of the Nasdaq
Composite today is the emergence of an evening star formation. (See Carolyn
Lueck’s trading lesson, “How
I Stalk and Pounce on Evening Star Formations
,” for a more detailed
explanation of this pattern.) This would suggest that Friday’s high could act as
a level of resistance, while the 50- and 200-day moving averages appear to be
the first support levels.


 

One leading stock that also
exhibited an evening star formation over the last few days is eBay,
Inc.

(
EBAY |
Quote |
Chart |
News |
PowerRating)
.  EBAY is a stock that many intermediate-term
traders may be holding long in their portfolios. It has strong fundamentals and
recently broke out of a long basing pattern. (Tim
Truebenbach
has astutely noted it in some of his recent reports.) 

As you can see, since the market reversed on March 12, EBAY has performed
extremely well.  It rose over 15% from its low on March 12 to its high on March
21.  The doji candlestick on March 21 was a warning though, that the sharp
run-up could be losing steam. The warning was confirmed today with the
completion of the evening star formation.

So how would a multi-time frame trader view, and take advantage of this
scenario?  Reversal signals like this one are a great place to take “rolling
stops.” A “rolling stop” is what most people do at stop signs — put your foot on
the brake, and look both ways, but never really stop unless there is another car
coming. It’s a temporary stop. You’re not getting out of the car (or
trade). You’re just stopping it in anticipation that you’ll be moving again
shortly. 

In the above scenario, the “rolling stop,” or exit signal would have been the
confirmation of the reversal doji.  This would have been just below Friday’s low
of $88.37.  An alternate exit could have been below the low of the first
consolidation after today’s big gap down, around $88.25.


Remember, this is a stock you
still want to own.  It’s making you money and the trend is up.  Therefore, treat
the exit (or rolling stop), as a short position in a lower time frame. In this
case, no matter which of the two rolling stop signals you took, reasonable
levels to get “stopped back in” to the position would be either above Friday’s
high, or above the high of today, which was established in the first 5 minutes
of trading.  In this case, I would most likely set my initial stop near today’s
high ($89.00).

Once the trade has gone in your favor as much as your initial stop, take part of
it off the table and move the remaining to breakeven.  In this case, assuming
you exited long around $88.25, you would want to buy back part of the position
at $87.50, and move your stop down from $89.00 to $88.25.

Continue moving your stop down as appropriate. You may want to look at the next
smaller time frame to do this (reversal pattern was based on daily chart).  For
instance, looking at a half-hour chart, you can see there is now resistance
building up just below $88.00.  This would be a reasonable area to move the stop
on the remaining shares.


If last Friday turns out to be
a significant turning point for eBay, and the multi-time frame trader is never
“stopped back in” to the trade, then they will have taken partial profits at a
very good time. If they are “stopped back in,” then they will have effectively
added the difference between their rolling-stop price and average re-entry price
to their profits. 

This kind of technique should only be used by intermediate-term traders who are
familiar with short-term trading tactics, and have the ability/time to
execute them.  I would encourage all intermediate term traders to study some of
the techniques of TradingMarkets day and swing trading contributors.

As the “rolling-stop” concept may be new for some of you, feel free to email me
with any questions or concerns you may have.

Best of luck with your trading.

Rob Hanna


robhanna@rcn.com