A QUICK LESSON IN PLACING STOPS
If you ever traded using Level 2 or something like TotalView, you know that there are orders placed-limit orders for stops and you can see them and the market maker or specialist and other traders are very aware of them as well.
Here’s where the problem comes in, what’s your favorite number? Maybe you picked 5 or 10 or 21, but you probably didn’t pick 4.27; that’s because the human mind gravitates toward whole numbers and when we set stops and limit orders, we typically set them at whole numbers. Why do you think Dow 10,000 is such a benchmark or S&P 1000?
Today watching the Q’s flirt with a break of $48, I sat and watched the volume as I was pretty sure what would happen, below is what happened:
Note how the volume picked up as price slipped below $48.00-it took 2 minutes to fill the limit orders-probably mostly stops.
Market Makers, Specialists and Traders all know this and an otherwise excellent stock that WILL appreciate in value will often see a fishing expedition in which one or more of the three entities named above will try to 1) pick up your shares on the cheap (long position as an example) 2) generate huge trading volume as the middle men, market makers and specialists receive much of their compensation in the difference between the bid/ask spread so higher volume means more money. Finally they often will do it to break up an obvious technical pattern and drive investors from it.
LESSON TO BE LEARNED
1) If you have a position that you think is likely to go your way, do not set a stop at a whole number and remember the selling as a one of these whole number fishing expeditions are breached, can often lead to more selling so you may want to give yourself a little more room below the whole number. If we were bullish on the QQQQ (which I am not), then a stop around $47.79 would make much more sense.
2) If at all possible-DO NOT PUT YOUR STOP ORDER IN THE SYSTEM-keep it in your head. If you were playing poker you wouldn’t show everyone your cards would you?
3) Stops (unless you are in the middle of a really horrendous move against your position) should always be executed as close as possible to the end of day close. This is when the big players come out and it is one of-if not the most important number in the day’s price action.
4) Now that you know this-use it to your advantage. They make money on it, why shouldn’t you?