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Hi All,
I came accross this in S & C Magazine interview with Don Bright of
Bright Trading:
Do you have any sort of stop associated with your buys or shorts? Is
it possible to post them with your entry? I have read in several
books that you should know your exit before you enter a stock. -
Bobdek
Using stop orders is tantamount to showing your poker hand to other
players. "Mental" stops, on the other hand, provide a trader with the
opportunity to scan the overall market conditions without being taken
advantage of. Here's one prime example of something that happens
every day: Assume a stock is trading 50.00/50.10 10x10. Now you see
the quote: 49.00/50.10 1x1. Your (sell) stop is 49.20.
Most experienced traders actually put in buy orders as quickly as
they can when they see the bid price drop, since they know that
a "negotiated print" is about to take place at a lower price. Then
the stock prints, say 100,000 shares at 49.10; your trigger goes off,
and you lose money.
In all likelihood, the stock will rebound near its previous price,
since this was simply an example of a "trade-through" aberration.
Since many brokers in the crowd (and market makers at firms)
are "holding orders" (so they can get extra commissions), they must
rush to buy the stock at their limit prices - at which the stock goes
back up - you lose. Now, if you were using mental stops, not only
would you not sell, you would actually be buying and making money.
Floor traders, specialists, and market makers understand this
phenomenon, and use it to take advantage of stop orders and pricing
variables.
Looks to me a good rule of thumb is to wait for about 20 minutes when
your mental stop is hit and if and only if you are still losing, that
it is prudent to exit the trade and not before, but there are certain
instances where a tight stop is essential, for e.g., trying to catch
the trend on a pulback, because if you are wrong about the trend, it
would be costly indeed. A better strategy is to optimize your entry
points based on volatility and a prediction of the next day's range,
in which case we can even afford to have a tight stop in all cases
and a uniform way of coding stops in AB.
Any thoughts?
rgds, Pal
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