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Wednesday, May 04, 2005
Market Recap
It was another super rally for stocks as they were up again for the forth straight day. The DOW had a triple digit gain of 128 points, the NASDAQ gained 29 points and the S&P gained 14 points. GM was the big reason that the DOW was up so much today. The futures were lower this morning until it was announced that there was a bid to buy 10% of GM stocks for $31.00, then the futures soared on the news and it was all GM for the rest of the day. When GM gains 15% in one day, you know the DOW is going to have a big day.
Oil closed above the $50.00 level today, up .63. It seems as though oil has no correlation to stock prices anymore. We can no longer use oil as an indicator for stocks. Inventories were up and the price of oil should have sold off on the news but, as usual the market did the opposite of what is logical and the shorts covered on this news and oil spiked along with the oil stocks. It was a case of short covering.
Market Outlook
This rally stinks if you are short and that is why you have to hedge your position in an over sold market, which we did by buying some stocks in the past couple of days. The reason I did not cover the shorts is because I do not cover shorts when the charts are showing bear flags. We know that we will have mini rallies because stocks do not go straight down. Having said that, the DOW closed over its 200 SMA today and the S&P closed above the 1163 resistance level that I have shown in the charts. The NASDAQ closed above the 1960 resistance level. This is very bullish for these three indexes however, we cannot forget that the NASDAQ is still below its 200 SMA and that there is important economic news to be released tomorrow and Friday. The indices are too close to critical turning points to predict which way they will go right now. Some unexpected bad news in these numbers released could kill any rally and close these indexes back below these levels.
Why do Stop Loss Orders Always Get Taken Out?
Since it is very possible that we could get caught short, I decided to discuss stop loss orders. Has this ever happened to you before? You set a stop and the price of the stock goes down to your stop price, takes you out of the trade at near the low of the day and then the stock begins to rebound right after you are out of the trade. We have all been victimized by those dreaded market makers, specialist, and floor traders that supposedly are “deliberately taking out our stop orders”. Well, I am not sure it is only the fault of market makers, but we all have to blame someone and so we place the blame with them. After all, it is their fault, correct? The truth is, in most cases, the reason stops get taken out so often is that they are simply placed at the wrong price.
Do Not Place Your Stop in the Daily Range
A lot of people trade with fear, they do not want to lose more than a certain dollar amount on any one trade. I will use $500 as an example. You say to yourself, I am not going to risk more than $500 on my next trade. So you purchase 500 shares of XYZ at $50.00 and decide to place a stop loss order at $49.00 because if it goes down $1.00, you loose your limit of $500. In my opinion, this is not a wise stop because it is based on a dollar amount and not a technical level it the chart. This stop price is good if you are buying this stock on a pullback to the trend line, support line, or moving average line because you would want a tight stop just below these levels, in case the stock falls through support. A stop at $49.00 would be an excellent placement if this is the case. The trouble is, a lot of people will place their stop based on a dollar amount rather than a technical level on the chart. As a result, the stop will get taken out because it is within the normal daily trading range of the stock. If you place a stop in the daily trading range, you have no chance.
Stops Congested at Support
Another reason stops are taken out is because there are millions of technical traders out there like you and I and we all know where the support levels are on the chart. If we are going to place a stop, we are going to place it just below these support levels and this will cause an over abundance of orders in this congested area. The specialists and floor traders know where these levels are in the charts and they also have the advantage of letting each other know on the floor at what price the bulk of their orders are. With all these stop orders clustered together, they can take the price down and the momentum will take out stop after stop, as they load up on their inventory picking off your shares. It does not take much to get the price down close to the stops and then make the final push to take them all out. After the momentum dries up, the stocks snap back as the floor traders unload that inventory after picking off all those shares near the lows of the day.
Use a Buffer Zone
This is legal for them to do so do not blame them for foul play. Yes, we are at a disadvantage but that is the way the game is set up and if we want to play, we have to live with it. Like a casino, we know those slot machines are stacked against us but we choose to keep pumping it full of quarters and silver dollars, even though we know the odds are in the casinos favor. All we can do is try to out smart them. The only way to do it is with a mental stop or, if you chose to set a stop loss order, you have to give yourself a buffer zone and place it just a little bit lower than the established support level to where you think everyone else has placed their stop. If yours is lower, you may not get taken out. You also risk being the last stop taken out, ouch. This is why I prefer mental stops.
Simple but Effective
Here is a simple but effective way that I use to enter my stops. I use mental stops because I can watch my stocks all day. When I enter a trade, I write down the price that I want to be my stop price. I write it on a post it note and plaster it to my monitor. When and if my trade reaches that price, I enter my sell order and I am out of the trade. If I am not going to be around to monitor my stocks, then of course I cannot use this tactic. When I am not around, I have no choice but to enter the stop order and be at the mercy of the market.
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