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Some Not-So-Great Tips for Using Stop Orders

Stock Trading to Go posted 10 Great Tips For Using Stop Loss Orders Successfully the other day. I’ll give the listing a middle grade. There are some good suggestions, but there’s also some stuff which range from perhaps too narrowly focused for general use all the way to just completely wrong.

First of all, I don’t agree with the idea put forth before the list of tips that stops are like insurance. Insurance makes you whole on losses suffered. Stops only provide a measure of assurance that they don’t get too large.

Here are the tips I’m good with:

2. Watch for hidden fees.
3. Never assume a stop loss order has been filled successfully.
6. New investors should use only stop market orders.
7. Use stop loss orders to setup a profit vs loss ratio.

In the case of #2, it’s a case where some brokers charge extra for non-market orders. And of course traders should always confirm all order entries and executions, which is #3.

In terms of #6, the comparison is against stop limit orders, which is where when a stop price is reached a limit order is activated rather than a regular market order. The difference is that a limit order will only be executed at the specified price or better. That means your order may not get filled, which you absolutely don’t want happening.

As for #7, I’ll go along with stops enforcing discipline and can help to better trade selection.

Now here are the ones I take issue with.

1. Never use stop loss orders for active trading.
4. For the original placement always give the stock at least 5% of space to avoid market maker abuse.
5. Don’t use stop loss orders for large positions.
8. Keep an eye out for after hours trading gaps.
9. Set the trigger price at common price increments.
10. Use with stocks that have high average daily volume.

Long-time readers of this blog know that I am not a fan of anyone using always or never in terms of trading rules, so you can guess my reaction to #1. That aside, the author is suggesting that because you’re in front of the screen watching the market you don’t need the stop. My contention is that stops help enforce discipline, and what happens if you are distracted by something while you’re trade is on?

Tip #4 is one that doesn’t fit many people’s trading. Short term traders, for example, may never expose themselves to a contrary move that large. I do, however, agree that stops should account for normal volatility.

Now for the really big problem for which I’m going to lump tips #5, #8, #9, and #10 together because they are all based on the same error in understanding. It’s one that appeared in the prior post that’s referenced at the outset of this one. The blogger is under the mistaken belief that a stop order will not get activated unless the market specifically trades at the order price. That is just flat out wrong, as this Investopedia definition indicates (italics mine):

What Does Stop Order Mean?
An order to buy or sell a security when its price surpasses a particular point, thus ensuring a greater probability of achieving a predetermined entry or exit price, limiting the investor’s loss or locking in his or her profit. Once the price surpasses the predefined entry/exit point, the stop order becomes a market order.

I tried to correct the blog author via comment when I saw the initial error, but it never went through (apparently). That site is one with a pretty large amount of traffic, suggesting the perception of authority, so I’m really surprised to see that kind of error being made.

7 replies on “Some Not-So-Great Tips for Using Stop Orders”

That’s actually a pretty funny list – thanks for sharing. “1. Never use stop loss orders for active trading.” – the list lost credibility right off the bat with that one. 😉

Hi John, this is a great post and we appreciate you taking the time to break down our list. When we wrote the post originally we were going based on our own experiences with actually utilizing these order types in our live portfolios.

Now every broker, situation, etc. is obviously different so you bring forth very valid points. The definition from investopedia is true but only is a definition and how it should work, “in theory”. Most recently for example my personal stop loss on USO was traded through by a measily $.xx and never triggered. I found out several days later (vice the other rule) and to my surprise I was down another 10% on oil.

The way we write our content is based on personal experiences and what we feel is in the best interest for our 40,000+ monthly readers. So even if they don’t agree (which happens often) atleast they are exposed to what is in the realm of, “possibility”.

Again, thanks for taking the time to write up a contrarian post and they are always welcome. Apologies for the comment not getting through you wrote, not sure what happened there. We are revamping our comment system with the new site launch coming in February.

Cheers!

Blain (stocktradingtogo.com)

Blain,

Thanks for stopping by and responding. It’s always nice to be able to develop an exchange will a fellow blogger.

To your experience with the missed USO stop, I can only say that in all my years trading (going back 20+) I cannot recall a single time in any market (stocks, futures, forex) where a properly placed stop order did not get filled. I do highlight the properly placed part there because I’ve certainly goofed on my order entries a few times along the way. It happens. Obviously the fill isn’t always at the exact stop price, but it’s always happened.

The first reaction I have when you say a stopped didn’t get hit is to question whether you put in the order correctly. If you are sure you did, then if I were you I would be all over my broker for the failure to execute.

If a simple stop order isn’t going to execute as designed then we all have to become day traders.

John

I have a question, as a newbie to trading, and using things like stops, etc. We had purchased a stock that started to go up… after it was in profit, we placed a stop order, for about .15 below the current trading price. Until our stop order, the stock was steadily (fairly quickly) headed upwards… but just in case we were not at the screen, we thought we would try a stop order.

I can’t figure out if we did something wrong, or what happened. But this is my perception of what happened -… within seconds of my placed stop order, the stock price steadily dropped to my exact stop price, my shares sold, and then headed right back up to the previous high, to go on higher. All within 5 mins or less.

I am aware stock prices fluctuate, but to my eyes, it seemed my lower “steal of a sale price” was noticed, somehow snatched up, and thing continued on upwards.

Prices can fluctuate, and I guess coincidences can happen. Or the more obvious answer may be that I didn’t place the order correctly, or understand what was to happen once I did.

My understanding was that this price was to execute only if the stock (naturally) dropped.. not to sell at this price immediately (which would otherwise seem kinda MARKET….).

I know this isn’t the case, but it seemed as if someone could read our price, got the stock prices to go down, grabbed ours at a “deal/steal” and then got the stocks to start moving up again. But I can’t grasp what did happen, likely because I have no experience, so likely a misunderstanding of stops altogether, or movement of stocks, in the least.

Any help in understanding this? Thanks so much for your time.

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