Doc Maher continues his lesson on using stops and planned exits.
In a previous post, I introduced the concept of swing trading. As with any kind of trade, managing risk and reward is essential to success. In this post I will begin to discuss how I handle these trades with profit targets and stop order placement. Keep in mind that there are many ways to deal with these trades and stop placement is often more of an art than a science.
THE PLAY - Buy Long Stock on a Pullback
TRADE FORMATION
On April 14, the following scenario occurred in AAPL stock:
High of the day: $149.25
Low of the day: $144.54
Most recent swing high: $159.69 on April 7
Target: $159.69
Potential entry: above $149.40 up to $149.50
Potential stop loss trigger: $144.50
Maximum gain: theoretically unlimited
Maximum loss: $149.50
Target gain: ~$10.19 (target - potential entry = $159.69 - $149.50)
Intended maximum loss: ~$5.00 (potential entry - stop loss trigger = $149.50 - $144.50)
Reward-to-risk ratio: $10.19 / $5.00 = 2.04
Time duration of trade: 2 to 6 days
ALL STAR COMMENTARY
Last time in Swing Trading with Stocks, I set up a hypothetical swing trade on AAPL. Here's a quick recap of the orders that I would have placed on April 14 using a One Triggers Other or OTO order.
Order #1: Buy Stop Limit Order for 200 shares of AAPL
Buy Stop: $149.40
Buy Limit: $149.50
Order #2: Sell Stop Order for 200 shares of AAPL
Sell Stop: $144.50
Here is a chart detailing the prices used:
Click here for a larger chart of AAPL on April 14.
On the next day, AAPL opened at my Buy Stop of $149.40, which then triggered my Buy Limit of $149.50. (See chart below.) Since the stock didn't gap up or move up very quickly from here, the order probably would have been filled somewhere between these two prices. For this example I will use the Buy Limit price of $149.50 and it will be my entry for the 200 shares. Once Order #1 of the OTO order would have been filled, Order #2 would have become activated and a Sell Stop order would have been placed at $144.50. To review: Order #1 of the OTO gets me into the trade and Order #2 of the OTO sets a stop to limit losses and exit (in this case on the down side).
Notice that on April 15, AAPL closed at $148.38, which is lower than my entry. I entered at $149.50 so I am down $1.12. However my stop is at $144.50 so I am still in the trade and following the plan that I outlined in the last post.
Click here for a larger chart of AAPL on April 15.
As part of that plan, once I enter a position I tend to manage my stop loss orders manually each night. Before I can do that, I need to cancel my hypothetical Sell Stop order to sell 200 AAPL at $144.50. After the cancel is confirmed I can place new orders.
Previously I said that I would take some of my position off if AAPL reached my target of $159.69. Let's round up to $160. The night that my entry order would fill, I would split the position of 200 shares into two batches of 100 shares each. In my next post I will explain in detail what kind of order I would place and how I would make further adjustments as the stock moves.
Until next time,
"Income Trader"
Doc's previous posts: Using Delta to Select Strikes for Strangles and Swing Trading With Stocks
For a list of previous All-Star Trades, please click here.
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Nicole Wachs contributed to this post.
Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.
Jonathan F. Maher, PhD has a professional business relationship with TradeKing.
