T2W Trading Community

Q - A stock breaks out and moves in my favor, but my stop gets hit most of the time on a pullback. How can I avoid this?

A - This scenario illustrates the major problem traders face when they chase breakouts. For example, you get a breakout and a strong move in your favor. You're taught to protect profits, so you place a stop-loss that guards some of the gains in anticipation of making more money when the stock runs. But the nature of price mechanics suggests that after an initial rally, a stock will pull back to test the original breakout level.

Both of your stop-loss choices have problems. First you protect profits with a trailing stop, but you risk getting hit when price pulls back to the breakout level. Second, you place the stop under the breakout level, but then you turn a winner into a loser. This also adds risk, because pullbacks often overshoot support-resistance just to get to the stops that are buried there.

The pullback from a rally is a two-edged sword, because it's a buy signal and a stop-loss level at the same time. In other words, if I'm already positioned I feel the need to sell, but if I'm not positioned, I feel the need to buy. The solution is counterintuitive and simple. Train yourself to avoid breakout entries and instead trade pullback entries.

Q - Should I lift my stop-loss when I know the stock will gap against my position when it opens?

A - I usually lift the stop-loss, but every case is different. Watch the pre- and postmarket trading, and see how much pressure the stock faces and whether it's trading above or below major support-resistance. The ability to hold higher price levels predicts that the stock will stabilize when the market opens. Keep in mind that New York Stock Exchange stocks may give few clues in extended hours.

When there's news that could affect the stock, I pull the stop loss and keep the position through the open. Then I try to hold for the first 10 to 15 minutes to see if it reverses or runs. If the stock starts to run or breaks a large support-resistance level, I get out immediately. The strategy can lead to a larger loss, but it's a tradeoff, because the gap prints the high or low for the day more than 70% of the time.

A - Some brokers hold stops locally, while others send them out to the "floor." But it doesn't really matter whether insiders see them or not because they know where you'll place them, even if they're not physical. Millions of traders came before you and applied the same logic to stop placement that you do every day. So unless you find a more creative way to accomplish this task, you'll wind up selling at the worst possible price anyway.

Q - Do market insiders see our stop-loss orders and purposely try to trigger them?

A - Some brokers hold stops locally, while others send them out to the "floor." But it doesn't really matter whether insiders see them or not because they know where you'll place them, even if they're not physical. Millions of traders came before you and applied the same logic to stop placement that you do every day. So unless you find a more creative way to accomplish this task, you'll wind up selling at the worst possible price anyway.

Q - Once a trade turns profitable, when do I adjust the stop loss to ensure I won't take a loss? And thereafter, if the trade continues in my favor, what rule do I use for trailing stops?

A - I figure an amount of initial wiggle room based on my goals for the trade. If the reward target is several points away, the stock needs to move around a lot, and I don't want to get in its way. If it's a small trade, I don't want to lose a penny after I get the first thrust away from my entry price.

The best strategy as the trade evolves is to use support-resistance on the 60-minute chart to move your trailing stop. For example, you get your rally and the stock congests for a few bars. When price breaks even higher, move your stop behind the last congestion pattern. This way, price needs to break the smaller support before it hits your trailing stop.

Get more aggressive as the stock approaches your reward target. Shift your strategy after the price passes 75% of the distance between your entry and intended exit. At that point, there's no sense risking a bundle in order to make a few pennies. Move the stop in close so any small reversal takes you out of the trade.