Doc Maher explains why this is a losing strategy.
Thanks for the comments on my prior post Moving Your Stop and Taking Profits, which was the third part in a detailed series on Swing Trading. In the post below I hope to answer those concerns. To catch up on the other segments, please read Part 1: Swing Trading with Stocks followed by Part 2: Managing Your Swing Trade. A post on swing trading options will be posted soon.
THE PLAY - Buy Long Stock on a Pullback
ALL-STAR COMMENTARY
As I noted, moving stops is more of an art than a science. We can never know if a stop position will be too close or too loose until after we see what happens in the future. A trailing stop is a perfectly reasonable way to go but you are confronted with the same fundamental problem. That is, how close do I put the stop?
There will always be times when a stop takes us out of a trade that eventually would have been profitable or more profitable. That doesn't mean that I am against stops. We can never get the last penny of profit out of a trade, so don't even try.
No one likes to take a loss but they are inevitable. No one makes money on every trade. I had a very old and wise trader once tell me that: ‘when you get to the point that your last trade doesn't affect your next trade then you have made it as a trader.' I asked him if he knew anyone like that and he said no. Me neither. But I have learned that when things go against me, I get out, take the loss and live to trade another day.
The big problem is there are too many times that I see people riding stocks down thinking (and later hoping) that they are going to turn back up. They even add to the position as the stock is falling. I never understood this strategy often called, "dollar cost averaging". I guess it means that I paid too much for the stock in the first place so if I add shares at a lower price that it is going to help some how. Or, I won't have lost as much on the first batch I bought. But in reality, of course the shares have lost and buying more won't change that, like throwing good money after bad. 'Bad money' is when the original trade is losing, but we all know losing trades come with the territory. 'Good money' is when you already know the original trade is wrong, yet you continue to add capital anyway.
I have had students show me positions that they have held for a very long time and they want to add to the position as it is dropping to lower their costs. We look at the chart and I say ‘would you buy this stock now?' Of course they say ‘No, it looks like we should short it.' My response is "Great, problem is you are long and you want to get longer." If you wouldn't open a position on a stock because it is falling, why would you add to that position? To me, when you add to a position it's another trade, not a continuation of the first.
I would rather get out and wait until the stock starts to go back up. If I still like it I can get back in. If it doesn't come back, no problem I'm out of it at a planned loss. If it comes back I can re-enter the position when it looks like it's trending my way again. If I get back in at a price that is at or below where I got out, great I lowered my cost. If not then it doesn't matter because each trade is a new trade and I don't want to let the last trade affect my next trade.
"Income Trader"
Doc's previous posts: Stay out of Trouble and Moving Your Stop and Taking Profits
For a list of recent All-Star blogs, please click here.
Options involve risk and are not suitable for all investors.
Please read Characteristics and Risks of Standardized Options.
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.
