I wrote about the market's strength after the close on Friday. It is nice but I am not overly worked up either way.
As I wrote that post on Friday I was watching CNBC's Closing Bell and I thought it was a little odd that everyone was so excited. The performance seemed to really whip up Bill Cara. Things like this aren't a big deal to me. Most people you read or watch have some sort of agenda. The more malignant you think their agenda is the less likely you are to respect what they have to say but CNBC does provide information. Part of the learning process is to weed out hype from information.
About ten years ago one of my older brothers tried to give me advice about the options market. He said something silly to me about options being manipulated or whatever. Aside from the fact that he had no experience working in the field and I had ten years under my belt my reply was "so what." You can only operate in the world that exists. The world won't adapt to you, you have to adapt to the world. So getting worked up about things beyond your control is wasted energy. I try to apply this to other aspects of my life too.
No disrespect to Bill, I don't doubt he is 100% correct on the issue but I'm just trying to help my clients and my readers.
I get a lot of second opinion emails where the answer includes something about a stop order. I wanted to repeat what I've written before about some of the strategic flaws of stop orders.
A stop order would not have worked on Biogen or Elan this past week, assuming your stop price wasn't 50% below the then market price. Anything close to a normal stop order under Biogen would have executed at $37.79 at the open on Monday (according to Yahoo finance) after closing at $66.45 the Friday before. In theory any stock could have news come out that would cause that stock to drop dramatically. A month from now $37.79 could look like an awful price to have sold at or a great price, there is no way to know.
Assuming a less dramatic situation; You bought your favorite energy stock a year ago at $30 and now its at $45. You put a stop in 8% below the current price to protect your gain, $41.40. The energy sector drops and your stock participates and you sell at $41.40. Now what? If you want a diversified portfolio you need at least one energy stock. Are you going to buy what you think is a lesser company, remember you just sold your favorite stock.
What if after you get stopped out the stock rallies back up quickly? Would you buy it at $43 after you sold it at $41.40? Too much of this and you are swimming up stream.
I have this discussion with one client in particular all the time. Stop orders are not the be all end all exit strategy. Stop orders are just a tool. Sometimes they will work and sometimes they will not.
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2 comments:
Hi, Roger. I don't know how many times I've been stopped out only to have the stock rally right back up again. Or worse, had it drop just far enough to trigger the stop and then bounce to a new high almost like there was some malevolent force behind the market that wanted to take my money.
I thought I was getting paranoid but then I read William O'Neil in "How to Make Money in Stocks" (page 55) recommend not entering stop-loss orders because the market makers will play games with the price to trigger the orders. Now I just size my positions appropriately, watch the stock closely via e-mail alerts, and if it really turns against me or something changes in the big picture I get out. It sounds like you use a similar tactic.
Roger, as usual, you make some good points. You've exactly nailed the problem with stop loss orders. However, in my mind the bigger picture is to have some criteria, ahead of time, before you enter a position, by which you will decide whether your thesis is wrong and you need to throw in the towel on something. If, as I do, you are making technical trades based on price, then a price-based exit ("stop loss") makes sense, because your thesis is based on price. (Of course, the problems you mention are still problems.) If, however, it is a fundamentals based strategy, then surely some fundamental criteria change will cause you to re-evaluate and perhaps exit the position.
Whatever, I think the key point is to have criteria, chosen beforehand, by which you will decide you are wrong, rather than riding the position down to nothing
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