Placing Stops….What You Should Consider

The point here though is the stop I listed. Stops are usually best exercised just before the end of day (EOD) , if you were to stop out on intraday volatility it would be very difficult to hold any position very long, even if you were right. The last hour is when the pros trade, especially the last 5-10 minutes, so that’s when we usually want to stop out unless there’s just a huge sell-off and then common sense and self preservation kick in, but you can always email me first to see what’s really happening.

Back to my point, the stops I provide are my estimates, I encourage you to adjust them according to your trading style. This particular stop came within 1 penny of being stopped out, I don’t know if I should say it was a great choice or a poor choice, but tops like we are in are volatile. I do NOT want to see you move your stops once you are in a position unless you are locking in profits, but this means that before you enter a trade, you must consider the extreme lateral volatility of a top, many great trades that we are 100% correct on, can be stopped out because we put a stop too close. I encourage you to use wider initial stops, according to our risk management, you take on fewer shares, that can all be rearranged once the trade moves in our favor.

You will notice many stops I list seem almost arbitrary, there’s a reason. Instead of a stop on a short of $18, I may put down $18.13, this is because the human mind is attracted to whole numbers. Therefore stops tend to congregate at whole numbers and that increases the likelihood of a false move by a market maker or specialist to trigger those stops,because they are the middle men and are the other side of a market trade, the last resort by law. Besides trading their own account in the stock they make a market in (which can represent 30% of that stock’s daily volume), they also fill institutional orders and they make a lot of their money on the spread, the difference between the bid and the ask. You’ve seen it before, the last sale maybe at $10, the bid is $9.97 and the ask is $10.02. The market maker, being the other side of the trade of last resort, will pay you 9.97 if you want to sell at market, and if you want to buy, the market maker will charge you $10.02, the difference of $.05 per share if the market maker’s profit. The more volume they can create, the more $.05 transactions they can rack up. An easy way to create that volume is by false breakout/breakdown. This is where they know where they stops are congregated, usually at a whole number but if you put in an order with your broker, chances are they can see your order along with everyone else who has put in an order for a stop or a purchase. Many books teach Technical Analysis tell you this is the second thing you should do after you enter a trade, it is wrong! You are showing your cards to the person who wants to take your shares. I always keep stops and orders in my head and only place the order when I’m ready to have it filled. These market makers can usually move the markets a bit to trigger these stops and a nice payday, you will commonly see it as volume jumps near whole numbers, obvious patterns and obvious support or resistance along with popular moving averages like the 50/200 bar moving averages. THIS IS WHY, I place a stop a little further away at an arbitrary looking number like $10.11 instead of $10 where human psychology kicks in as our minds gravitate to these types of whole numbers. It’s the same reason that retailers use a number like $99.99 rather then $100. It’s only a penny difference, but in our minds, there’s a big difference and retailers have known it for years.

So keep your stops initially a little wide, try to avoid placing them with your broker until you are ready to execute them. Do not put them next to anything obvious. This is one of the things about technical analysis I talk about that was meant to help, but has become a trap, such as putting a stop at a 50 day moving average, smart money knows traders are all looking at the same level and they will shoot for that level to knock all these traders out of their positions, get shares cheaper and create a good income flow for the day as you multiply the spread by the volume surge created by those stops being hit. You should also consider all of this BEFORE you enter the trade and make sure it’s a part of your risk management planning (see the link at the top right of the site on risk management).

It’s ok to use a tight stop, if that is your plan. Many professional traders will do exactly that, but the difference is they may enter the trade 4-5 times before they get the position they want, amateurs tend to walk away from a failed trade. If you use a tight stop, make sure it keeps the losses very small, then you can afford to enter the trade multiple times until you get the positioning you were after.

Here’s an example of what I’m talking about….

Click the chart to enlarge. The first red box shows a surge in volume as traders commonly place stops at or just below the 200 day moving average in blue. Technical analysis books have many times claimed that a move above or below the 200 day moving average is a buy or sell/sell short signal, thus traders have stuck with this antiquated idea. The first day the Specialist (same as a market maker for the most part, just operates on the NYSE rather then the NASDAQ) took prices just below the blue 200 day moving average and triggered stops and limit orders, then closed MCD above that level, putting shorts at a loss and taking positions from longs who were stopped out. The increase in volume meant a good pay day as you multiply the stocks spread by the number of shares traded that day, it was a good move for the specialist and didn’t require them to take the stock too far down, just enough to trigger the stops, which they can see in their order book. The stock moved up the next two days as did the broader market, traders probably figured the stops had already been hit and again put stops/limit orders below the 200 day moving average, again, they we taken out a second time on another volume spike. After that the stops has been cleared, that’s why there’s no subsequent rise in volume the next few days below the average. The next play was the third candle in red, this day they took out the lows that had been previously established, a common place to put to stops and the specialist took out the $60 level, an important whole number where stops were surely congregated.

Here we still have the 200 day moving average in blue, but I’ve added the SPY in red so you can see that the first day stops were hit, the market was moving up/closing up. MCD moved up the next two days with the market, many traders most likely believed that MCD would follow the market as many stocks do, which led them to place stops a second time under the 200 day moving average (in the red box) which again were taken out and the stock closed higher. This gives the specialist a chance to take the shares cheaply and sell some into higher prices that day, others they can hand onto for the move down. As I illustrated at Trade-Guild last night, these moves are planned in advance.

This is the run on stops you can see on the first chart, it is the last or third box highlighted in red. First lows were set previously, many stops will be at those lows, secondly $60 is a whole number that many stops will congregate at. This is what I call a “Crazy Ivan”, when all stops are taken out and all limit orders of any volume and consequence are taken out. You can see the huge volume on this 5 minute chart of July 30th. You can see how quickly all the stops were hit and the spike in volume it caused (remember-part of a market makers/specialists income is the spread multiplied by the volume, the more volume, the more money they make). If they believe they can hit a large cluster of these stops, they will try to do that as can be seen here, the stock closed higher for the day (seen in the white box).  There were nearly 2 weeks in which the specialist had an opportunity to sell positions they accumulated this day at $60, they could also hold what was left as the process of distribution and the stock moving lower takes some time, anything they sold short, would not be at a profit.

I will continue to point out examples like this as they occur, it’s important for you to understand how their manipulation in the markets will effect or not effect your positions. Many of the traders who had short sale orders triggered that day saw higher prices in the weeks to follow and many would have been squeezed out of their positions.

Just keep in mind these rules, if the stop level is obvious to you, it’s obvious to everyone. Stay away from obvious levels, including support and resistance areas, moving averages, trading range breakout areas, former lows that may be perceived as support, and especially whole numbers. As I see them, I will document them for you, each one will give you new insight into how the market really works.

If you haven’t seen this video already, listen to Cramer’s own words. This is a smart man, I just have questions about his allegiances as I have had experiences like the week I called the end of the 5+ year uptrend in oil using 3C, the same week he was telling viewers to buy oil. He is very well connected to Wall Street and is a GS alumni. I believe that he has information or had information that is far superior to what he calls out every night. The distribution in oil didn’t happen overnight, it was a process and I am simply questioning the fact that he has the connections on Wall Street to understand more about the situation then perhaps he lets on? Remember what CNBC is, a media outlet. What is their primary goal? To make money. Is it possible that the reality of business may at times conflict with the viewers best interests?  I’ve heard Cramer bash shorts up and down before, obviously it is a tactic he employed when he ran his fund, it’s not necessarily the best way though to gain corporate advertisers and sponsors by saying you should short their companies, I doubt very much they’d be very keen on the idea of doing business with CNBC in the future. I’d really like to see the Mad Money disclaimer that flashes across the screen in very small words, if anyone has a screen capture of it please send it to me.