My long term readers know I am a great believer in protecting customers’ capital with the use of open stop loss orders.
I continue to believe in them, but there have been changes in the overall market that make it necessary to change the kind of stop loss order.
What you buy, when you buy is still up to you, but stops have become very dangerous especially in the major issues that are well traded.
We have seen what are called “flash crashes”. Sudden horrific losses that are triggered by an event may be true or false taking issues down 20% or more in minutes or even seconds. Those with open stops have their orders filled at the lowest point. That is what the manipulator wants – your stock at a cheap price.
High Frequency Trading (HFT) is being used to run stops and manipulate equities. The SEC is not doing their job. The recent crash in gold is a perfect example.
Millions of shares may trade in a few moments. Too late. You are caught and nothing can be done about it.
One of the defenses can be a limit stop loss. Your stop must be filled at your price or it is not filled. This will protect you in one of those flash crashes.
There is one I prefer more. It is one you will have to watch, but not too closely. It is a trailing moving average. I am a great advocate of DIRECTIONAL Moving Averages not the price penetration of the moving average line. The Two for the Money explained in my book has made money every year since 2000.
Let’s suppose you owned Apple from some point about 200 and had been staying with it for years. It has made money every year until recently. Did you sell? Don’t you wish you had, but where?
A 50-day Moving Average started up in 2009 at about 125 and did not turn down until about the end of the 3trd quarter of 2012 at about $600. You AAPL owners know it is trading about $400/share today. Any type of flash crash or change in business conditions for the company would not have affected a stop.
It is up to the investor to choose the type of moving average he will be comfortable with. It could the 50-day, 100-day, 20-day or a more sophisticated oscillator of 2 moving averages.
Apple is an example. This method may be applied to almost any stock, index, ETF or mutual fund. The investor may choose the time period.
Review each equity in your portfolio. Determine how this will work for you.