6/11/09  This happens a LOT to all rookies and will EAT your money alive.  Received an email this morning with the subject “HELP” from a friend of mine.  He had bought into a small cap stock this morning which began to climb higher, then quickly took a nosedive; stopping him out for a loss.   He was realllllly P.O.ed and wanted to know what he had done wrong.  Was his stop the problem?  Let me break this down:

1. The stock opened and came out of the gate strong, rising immediately.   I’m sure he thought he had a winner.  But then 10 minutes later it rolled over going below the open and he was stopped out for a loss.  To add insult to injury, once he was out, the stock bounced, turned around and went higher.   No wonder he was angry.  Lesson #1  Either wait until 1/2 hr after the open to determine true direction, or use a better stop.   This one was way to close.
2. His stop.  He had placed his stop just below the open which might sound prudent to some, but I generally use yesterdays LoD (low of day), a stop just below a moving average or if the stock had formed a pattern or base and was breaking out, my stop would be below *that* base.  Lesson #2 Give your trade some breathing room.  Don’t have your stop too close.

For some people the problem can sometimes be money management.  This was not his problem in this trade but I think I should mention it a little here.  Let’s suppose his risk tolerance for a loss was $100.  If his stock were $85/share, trust me, it’s going to swing $3-6 easily during  the day and chances are you will be stopped out.  In this trade he could not have used a lower stop and stay within his risk tolerance; just not enough room.   So what to do?    There are many strategies but the easiest  is to buy fewer shares, maybe a 1/2 or 1/4 size position so that your $100 stretches further and you can use a safer stop limit.  All trades need breathing room and market makers will intentionally go below a moving average or LoD to try to knock out the rookies.  This way you have plenty of breathing room and a greater chance they won’t get you.  *If* the trade works, you add to that winning position and ride it higher; but if it fails, then the stock is probably falling for real and it was just a bad trade.

There are many other methods, waiting for better entry points, dollar cost averaging, options, the list goes on but this gives you the basic idea.  The best idea:  If the risk is too high, take a pass and don’t trade it.  There are 15,000 other stocks out there.  You’ll find another one.

Its also prudent to re-examine and analyze your entry/exit points on trades from time to time.  You’ll be amazed by how much you learn when you see what you could’ve done differently or entered the trade at a better level. 

Have fun ♥