During a group meeting with our newest traders we discussed a Double Bottom in Valeant (stock symbol VRX), that triggered a buy from a new trader on our desk.
Newb: I saw VRX holding near 62, so I got long.
Me: Where was your stop?
Newb: 61.90
Me: So you got stopped out?
Newb: No
Ok so now we have a trading issue. VRX touched below 61,90 so the trader should have gotten stopped out if he was honoring his stop.
Me: It touched below 61.90, how did you not get stopped out?
Newb: Well it did not trade below there for long.
Me: So your stop was price AND time? How much time did you want it to hold below 61.90 for your stop to trigger?
Newb: Maybe a minute?
Me: What would have done if the stock went from 62 to 55? Because that will happen at a few times a year. It only takes one crazy move to end your trading career.
The trader thought and replied….
Newb: I would have hit it out below 61.74.
Me: I thought you said your stop was 61.90?
The trader did not have a clear enough stop loss plan for this trade. And you could tell from his explanation that he was undervaluing how important it was to play defense with his trading. He was very confident the trade would work. And it did by the way. And this is a worthwhile trading setup to study for your trading. But what if it didn’t?
During lunch I was discussing how training was going with a different new trader. He remarked how he was eliminating some bad habits, like not keeping definitive stops. Oh like his training classmate above. Very interesting.
So two, very bright, very interested in markets, new traders, during the same day display their struggle with keeping definitive stops.
Sustaining and consistently profitable traders declare definitive stops before they enter their positions. As you gain experience those stops will become more nuanced. A new trader might set a stop of 61.90. An experienced trader might set a stop of 5 minutes holding below 61.74 OR below 61.49 OR if the stock does not bounce from the 62 level in 15 minutes.
Being unclear about your exact stop loss will cause you to miss necessary exits and take larger than necessary losses in these fast moving markets. Once that new trader had to think what he would have done if VRX dropped sharply below 61.90, his stop plan was not sufficient.
Be definitive. Be crystal clear. Determine stops prior to entry. Honor them.
And then review your stop strategy.
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A trade to increase your stop loss
* no relevant positions
