Stop Loss Question

[burglar]

Not sure if it has been mentioned, or is relevant (it should be), but a stop loss only reduces the risk of your market exposure via the security if it sells! It is not a gaurantee as far as I know. If you have a stop loss at $7.50, and the security goes into a trading halt at $7.60 and re-opens at $4 I am fairly certain you have lost much more than you anticipated!

Perhaps you could use some sort of derivatives to avoid this scenario?

We all have to start somewhere.
Worrying about gap downs of this magnitude would have me not sleeping at night.

I know the risk is real, but I have ignored such risk because I like sleeping!
I do minimise this risk by extensive study.

 

[Ves]

You would still be in the trade if the stock didn't trade AT $7.60
Unless you place a stop limit order.

Yes exactly, $7.60 is merely an example. Anything above $7.50 works in that example. The point is that a massive gap down whilst you are still in the trade will not be de-risked by use of a stop loss!! As you said liquidity at the price you want to exit is essential.

 

[skc]

Not sure if it has been mentioned, or is relevant (it should be), but a stop loss only reduces the risk of your market exposure via the security if it sells! It is not a gaurantee as far as I know. If you have a stop loss at $7.50, and the security goes into a trading halt at $7.60 and re-opens at $4 I am fairly certain you have lost much more than you anticipated!

Perhaps you could use some sort of derivatives to avoid this scenario?

Yes it is bound to happen the longer you trade. You can abuse fixed fractional positioning - say it's a $10 stock and you "think" your stop loss is 5c. You "think" you are risking 2% of your $50k capital ($1k), so you bought 20,000 shares @ $10. Little did you realise that you've just put on a position 4x your account size.

5 minutes after you bought, the stock goes into trading halt, announces bad news and opened at $6.20. You've just lost $76k, completely blown your account and still owe your friendly CFD provider $26k.

That's why I always believe in a sense check of total exposure vs account size. Depending on the risk appetites - say you think the worst case scenario the stock will move 50% against you and you never want to lose 15% of your capital in a black swan event.... then keep your maximum position size to 30% of your account. In the above example, you would have bought 1500 shares instead, and the gap would cost you $5,700. Still hurt as hell but you survive to fight another day.

With some stocks, some CFD providers offer guaranteed stops. But they do cost money and add up quickly over time if you use them on every trade. They also limit how close you can put the stop (usually 10%) so a trigger still hurts a lot. I have used them occassionally on binary events (e.g. ACCC determination on Austar takeover) but overall with mixed success. I guess they priced those guarantees with a fair bit of margin so there's not much of an edge to the average trader.

 

[Ves]

Thanks skc - I think you have conveyed perfectly what I was trying to get at in terms of "exposure" vs the more commonly held view of "risk."

 

[sinner]

Perhaps you could use some sort of derivatives to avoid this scenario?

When it comes to single names it's pretty much down to options and not so easy for single names on the ASX unless you're trading the ASX20 and don't mind paying a lot for the privilege!

"Hedges" cost alpha (be they stoploss or derivatives) no matter what, so sizing your capital as skc suggests is often the solution that most safely protects your capital for the cheapest cost.

 

[IFocus]

Thanks skc - I think you have conveyed perfectly what I was trying to get at in terms of "exposure" vs the more commonly held view of "risk."

Have always applied the how do I get up and trade next day if I lose 50% on a position, position size accordingly as stated trade the markets long enough and it will happen one day.

In a market the size of the ASX (small) many stocks are heavily correlated so often you can spread your position across 2 or more stocks.