Stop losses and their effect on price

MrCho · 14 November 2009

Hi, I'm new to the share market. A bit about me. I'm an fairly new accountant, but I've managed to save up a fair bit to start trading. I've read the basics of both fundamental and technical analysis. They're both pretty interesting views.

I have a query about stop losses. My basic understanding is that a stop loss protects your loss or a trailing stop loss will lock in your profit while protecting yourself from risk. If your a purely fundamental trader, it makes no sense to put in a stop loss. If the underlying value of the company doesn't change, it actually makes sense to average down. Instead of selling stock, buy stock when it moves down, so long as the underlying value does not change. Mr Market acts irrationally sometimes in the short-term but eventually price will move upwards to reflect fundamental value. Technical analysis views it differently. A stop loss is important to protect risk. A stock can trade on momentum. That's the basic gist of what i understand. Please correct me if i'm wrong.

Here's my question. If there are alot of traders using stop losses on stock. Once it reaches a below a certain price, won't the stock be heavily oversold? The stop loss creates a big selling momentum which will undervalue the stock from a fundamental point of view.

So_Cynical · 14 November 2009

Re: Stop losses and its effect on price

Hello MrCho and welcome to ASF...great first post and i 100% agree with its content.

Many newcomers don't understand the diversity of trading/investing styles that are practised by the many people involved with buying and selling shares....it will take a while for u to get your head around the many different philosophy's and disciplines they follow.

One such discipline is called "trend following" and to be a successful trader following this discipline one must follow the rules of trend following and limit losses by selling when a certain loss point has been arrived at, the rules of trend following are all important as any break from the rules is a break from the system and there fore could be considered gambling.

As for your question, once again i agree, but what u have to understand is that trend followers don't make value judgements, fundamentals are irrelevant to them...its all about the price action and capital protection.

As for myself, im happy to hold and average down and wait for the market to catch up with me and give me my just rewards....as it now is.

all$andnocents · 16 November 2009

Re: Stop losses and its effect on price

i'm no expert but you'd hope once the price drops to certain limits there'd be people on the sidelines thinking that there's value to be had.

correct me if i'm wrong (not that needs to be said here!)

cutz · 16 November 2009

Re: Stop losses and its effect on price

all$andnocents said:
i'm no expert but you'd hope once the price drops to certain limits there'd be people on the sidelines thinking that there's value to be had.

Yeah,

Nine times out of ten that's what's meant to happen but occasionally it appears that there's no value at any price.

AlterEgo · 16 November 2009

MrCho said:
Hi, I'm new to the share market. A bit about me. I'm an fairly new accountant, but I've managed to save up a fair bit to start trading. I've read the basics of both fundamental and technical analysis. They're both pretty interesting views.

I have a query about stop losses. My basic understanding is that a stop loss protects your loss or a trailing stop loss will lock in your profit while protecting yourself from risk. If your a purely fundamental trader, it makes no sense to put in a stop loss. If the underlying value of the company doesn't change, it actually makes sense to average down. Instead of selling stock, buy stock when it moves down, so long as the underlying value does not change. Mr Market acts irrationally sometimes in the short-term but eventually price will move upwards to reflect fundamental value. Technical analysis views it differently. A stop loss is important to protect risk. A stock can trade on momentum. That's the basic gist of what i understand. Please correct me if i'm wrong.

Here's my question. If there are alot of traders using stop losses on stock. Once it reaches a below a certain price, won't the stock be heavily oversold? The stop loss creates a big selling momentum which will undervalue the stock from a fundamental point of view.

If you've read a number of trading books, you should have read in at least one of those books to never average down. It's the biggest mistake that beginners make, and often results in them losing very large sums of money. Yes, it usually works....... until it doesn’t, and the time it doesn’t you find you have most of your capital tied up in a downward trending stock (because you’ve been buying more and more all the way down), which can often stay down for years or go bankrupt.

You say “If the underlying value of the company doesn't change…..”, but the problem with that is, how can you be sure that something hasn’t changed that you’re not aware of?

skc · 16 November 2009

MrCho said:
Hi, I'm new to the share market. A bit about me. I'm an fairly new accountant, but I've managed to save up a fair bit to start trading. I've read the basics of both fundamental and technical analysis. They're both pretty interesting views.

I have a query about stop losses. My basic understanding is that a stop loss protects your loss or a trailing stop loss will lock in your profit while protecting yourself from risk. If your a purely fundamental trader, it makes no sense to put in a stop loss. If the underlying value of the company doesn't change, it actually makes sense to average down. Instead of selling stock, buy stock when it moves down, so long as the underlying value does not change. Mr Market acts irrationally sometimes in the short-term but eventually price will move upwards to reflect fundamental value. Technical analysis views it differently. A stop loss is important to protect risk. A stock can trade on momentum. That's the basic gist of what i understand. Please correct me if i'm wrong.

Here's my question. If there are alot of traders using stop losses on stock. Once it reaches a below a certain price, won't the stock be heavily oversold? The stop loss creates a big selling momentum which will undervalue the stock from a fundamental point of view.

If you are trading fundamental you are buying a company, so the "value" of a company matters. Having a stop loss based on price doesn't make sense in this case. But the mistake for most traders / investors using fundamental analysis is not knowing when they are wrong. They can't accurately assess how new information affects the value, and they are unwilling to part with their shares and take losses when they are proven wrong / likely to be wrong. So imo trading fundamental you still have a "stop". This stop is not based on a price level but should be based on fundamental information triggers (eg. falling sales, lower margins, new regulations etc).

With technical analysis, value doesn't matter that much as price is the only reality. As a technical trade you will have no hesitation buying a stock at $4.50, the same stock you just sold at $4 only last month. In this case the stop loss is most important and clearly should be price based. You will often see some obvious places for stop loss and once triggered the stock is rapidly sold off.

So either way you should have a stop loss - and the trigger of the stop depends on why you entered the trade in the first place.

motorway · 16 November 2009

skc said:
If you are trading fundamental you are buying a company, so the "value" of a company matters. Having a stop loss based on price doesn't make sense in this case.

It would depend on how many shares / % of a company, You are buying and how quickly you want to do it...

What is wrong if you are only are buying 10,000 shares based on "Fundamentals"
and you use a PRICE stop...

It goes UP.... Fine

It goes down ... You make a small loss.. That's OK you have a TAX loss to claim. And when it stops going down You can Buy at a better price .

Of course if it does not stop going DOWN ?
Maybe there are those who know more than you !
OR Conditions , Bear Market ? Keep "Investors" ( real ones ) on the sidelines

Things to consider:

Market Trend
Sector Trend
Stock trend

& How many shares you want and how quick
If you are launching a takeover and need to keep others on the sideline
YES a Stop Loss is maybe a disadvantage.

If you want to BUY 10,000 shares and that's it..
because of the way Shares TRADE ( if you really want to buy JUST a business you would have to buy into an unlisted one )
Such tactics as STOPS can be useful..

All you need is Robust and Timely Indication of when something goes Down and When it Stops Going DOWN... ( note indication--not indicator...--> What you need is a robust and timely TREND definition )

Motorway

motorway · 16 November 2009

MrCho said:
Hi, I'm new to the share market. A bit about me. I'm an fairly new accountant, but I've managed to save up a fair bit to start trading. I've read the basics of both fundamental and technical analysis. They're both pretty interesting views.

Here's my question. If there are alot of traders using stop losses on stock. Once it reaches a below a certain price, won't the stock be heavily oversold? The stop loss creates a big selling momentum which will undervalue the stock from a fundamental point of view.

Mr Cho
Consider--->

THE SOURCE OF LIQUIDITY

If all information had the same impact on all investors, there would be no liquidity.

When they received information, all investors would be executing the same
trade, trying to get the same price. However, investors are not homogeneous.
Some traders must trade and generate profits every day. Some are trading to
meet liabilities that will not be realized until years in the future. Some are highly
leveraged. Some are highly capitalized. In fact, the importance of information
can be considered largely dependent on the investment horizon of the investor.

Take a typical day trader who has an investment horizon of five minutes and
is currently long in the market. The average five-minute price change in 1992
was — .000284 percent, with a standard deviation of 0.05976 percent. If, for
technical reasons, a six standard deviation drop occurred for a five-minute
horizon, or .5 percent, our day trader could be wiped out if the fall continued.

However an institutional trader—a pension fund, for example—with a
weekly trading horizon, would probably consider that drop a buying opportunity
because weekly returns over the past ten years have averaged 0.22 percent
with a standard deviation 2.37 percent

In addition, the technical drop has
not changed the outlook of the weekly trader, who looks at either longer technical
or fundamental information.
Thus, the day trader's six-sigma event is a
0.15-sigma event to the weekly trader, or no big deal. The weekly trader steps
in, buys, and creates liquidity. This liquidity, in turn, stabilizes the market.

All of the investors trading in the market simultaneously have different investment
horizons. We can also say that the information that is important at
each investment horizon is different. Thus, the source of liquidity is investors
with different investment horizons, different information sets, and consequently,
different concepts of "fair price." Edgar Peters

Motorway

MrCho · 17 November 2009

First of all, thank you for your replies. They're quite informative. I think i've barely scratched the surface

AlterEgo said:
If you've read a number of trading books, you should have read in at least one of those books to never average down. It's the biggest mistake that beginners make, and often results in them losing very large sums of money. Yes, it usually works....... until it doesn’t, and the time it doesn’t you find you have most of your capital tied up in a downward trending stock (because you’ve been buying more and more all the way down), which can often stay down for years or go bankrupt.

You say “If the underlying value of the company doesn't change…..”, but the problem with that is, how can you be sure that something hasn’t changed that you’re not aware of?

The line i've read in trading books about averaging down is that it's like sending more money down bad money.

The way you've put it AlterEgo makes sense. That something that could of changed may not reflected in the underlying value. If you put it that way, then that's a huge flaw in the fundamental value perspective.

MrCho · 17 November 2009

what i got from skc is that - price stop losses don't make sense for buying using fundamental analysis. the stop loss should be based on the earning potential of the company. since technical analysis is based on price analysis, a price stop loss makes sense. fundamental analysis is based on earning potential (among other things), a stop loss should be based on these fundamentals.

motorway said:
All you need is Robust and Timely Indication of when something goes Down and When it Stops Going DOWN... ( note indication--not indicator...--> What you need is a robust and timely TREND definition )

Motorway

motorway, when you mention trend definition - are you referring to using technical analysis together with the fundamentals?

MrCho · 17 November 2009

motorway said:
Mr Cho
Consider--->

Motorway

cheers for the liquidity blurb. answered my question

lukeaye · 17 November 2009

Hi there welcome,

For me as a technical trader, price is rarely wrong. There are maybe 1 out of 100 circumstances when i could say, the price is not reflecting what should be happening. Such occurances can be seen in arbitrage.

Having said that, price is subject to cause and affect. There is always a reason price will move, whether you can rationalise it is irrelevent, as alterego said, there are many people that will know things before the market does, or you.

There is alot that fundamentally makes no sense at the moment, but technically there as so many oppurtunites.

motorway · 17 November 2009

lukeaye said:
Hi there welcome,

For me as a technical trader, price is rarely wrong. There are maybe 1 out of 100 circumstances when i could say, the price is not reflecting what should be happening. Such occurances can be seen in arbitrage.

Having said that, price is subject to cause and affect. There is always a reason price will move, whether you can rationalise it is irrelevent, as alterego said, there are many people that will know things before the market does, or you.

There is alot that fundamentally makes no sense at the moment, but technically there as so many oppurtunites.

price is rarely wrong

PRICE is ALWAYS WRONG esp for someone..

At best a Traded price can be seen as a compromise
Where differences of opinion have agreed to disagree..

MrCHo --> What are Fundamentals and how do you trade them
What are the technicals and how do you trade them..

In the markets All anyone can do is BUY or SELL---> Shares

There are different Information Sets , Different Time Horizons
There are those who are better or less informed

But this all comes together because When anyone wants to act:

They have to BUY or SELL

If all information had the same impact on all investors, there would be no liquidity.

But there is Liquidity !

Market dynamics are NEVER stationary. ( IE The price is always WRONG It keep changing It has to keep changing)

Markets represent the intersection of many different and conflicting interests, expectations and behaviors. Instantaneous shifts in supply and demand determine price, moving the market toward thresholds (stopping, selling, buying) . Richard Olsen

So the Most Important Thing to know about a Market or a Stock ?
Given what a market is ?

Richard Wyckoff taught that the most important thing anyone can know about a market or an individual issue is its trend and the position that it occupies in the trend.

The trend is the line of least resistance. It indicates the direction in which the price wants to move. Profits are more likely to be realized when positions are established that are in harmony with the direction in which the price has already indicated it wants to move.

Just look at ( recent ) History

Motorway

lukeaye · 17 November 2009

motorway said:
PRICE is ALWAYS WRONG esp for someone..

At best a Traded price can be seen as a compromise
Where differences of opinion have agreed to disagree..

Motorway

Ok well i agree in that context, for me to buy and you to sell we are disagreeing on the value/price of the underlying. But even value is subjective, just because there is supply at a level does not mean that the seller or buyers believe this is the correct value of the stock, there can be buying or selling for another reason. But that does not make it wrong?
How can it be wrong if we have transactions?

Price is always right, what is right is dynamic though.

To me, for a price to be traded at that very moment, it is accurate in relation to supply or demand for that moment.

Once again i think its a contextual interpretation.

kam75 · 17 November 2009

MrCho said:
Here's my question. If there are alot of traders using stop losses on stock. Once it reaches a below a certain price, won't the stock be heavily oversold? The stop loss creates a big selling momentum which will undervalue the stock from a fundamental point of view.

There's no such thing as overbought or oversold. Just supply and demand. And buying pressure or selling pressure.

For example. A big newsletter stock tipping company may have just mailed out their Sell alert on BHP. Hundreds of their members follow the guru's advice religiously, like sheep, and set their stops at the same price. The stop is triggered and their orders all go to the market. So what. The price pulls back to an intraday low as the market absorbs the large share parcel before resuming to close near the high by the end of the day.

weird · 17 November 2009

MrCho said:
Hi, I'm new to the share market. A bit about me. I'm an fairly new accountant, but I've managed to save up a fair bit to start trading. I've read the basics of both fundamental and technical analysis. They're both pretty interesting views.

I have a query about stop losses. My basic understanding is that a stop loss protects your loss or a trailing stop loss will lock in your profit while protecting yourself from risk. If your a purely fundamental trader, it makes no sense to put in a stop loss. If the underlying value of the company doesn't change, it actually makes sense to average down. Instead of selling stock, buy stock when it moves down, so long as the underlying value does not change. Mr Market acts irrationally sometimes in the short-term but eventually price will move upwards to reflect fundamental value. Technical analysis views it differently. A stop loss is important to protect risk. A stock can trade on momentum. That's the basic gist of what i understand. Please correct me if i'm wrong.

Here's my question. If there are alot of traders using stop losses on stock. Once it reaches a below a certain price, won't the stock be heavily oversold? The stop loss creates a big selling momentum which will undervalue the stock from a fundamental point of view.

If you had applied that theory to ONETEL, and other similar stocks (and there have been many ... anyone want to post ?) ... and I wonder if you will be around to post further if you haven't learned otherwise

motorway · 17 November 2009

lukeaye said:
Ok well i agree in that context, for me to buy and you to sell we are disagreeing on the value/price of the underlying. But even value is subjective, just because there is supply at a level does not mean that the seller or buyers believe this is the correct value of the stock, there can be buying or selling for another reason. But that does not make it wrong?
How can it be wrong if we have transactions?

Price is always right, what is right is dynamic though.

To me, for a price to be traded at that very moment, it is accurate in relation to supply or demand for that moment.

Once again i think its a contextual interpretation.

So there are trends because the Price is Always Right ?

No there are trends because the price is always wrong !

Yes in a static sense Price is "right"
But in a Dynamic Sense NEVER

There is always a Trend
A Line of least resistance

Why ? Because The price Right now is Always WRONG.
On All or Certain Time Horizons..

The Most dynamic trends might well
Occur when on ALL Time Horizons
The PRICE IS WRONG

Top of a Bull Market
Bottom of a Bear market

Motorway

weird · 17 November 2009

motorway said:
So there are trends because the Price is Always Right ?

No there are trends because the price is always wrong !

Yes in a static sense Price is "right"
But in a Dynamic Sense NEVER

There is always a Trend
A Line of least resistance

Why ? Because The price Right now is Always WRONG.
On All or Certain Time Horizons..

The Most dynamic trends might well
Occur when on ALL Time Horizons
The PRICE IS WRONG

Top of a Bull Market
Bottom of a Bear market

Motorway

MW, don't get that post, I don't wish to, and take u r in jest, but will tear u a new one if need 2.

nomore4s · 17 November 2009

weird said:
MW, don't get that post, I don't wish to, and take u r in jest, but will tear u a new one if need 2.

Tear him a new one for what? Posting his views on a subject?

Maybe if you can't add anything constructive to a conversation you should just let it be.

motorway · 18 November 2009

weird said:
MW, don't get that post, I don't wish to, and take u r in jest, but will tear u a new one if need 2.

Well What to Say

maybe Nothing

But if Price is Right
There are No trends

Price is right is part of Strong Form of Efficient Market Hypothesis
And with that there are No Trends

I think Strong form of EMH is Wrong

I think there are Trends and I think Price is Best Seen Dynamically as Wrong
in the context of Futures Prices..
And Only Future Prices and TRENDS ( NEED BOTH )
Make trading $$$$

Trend --> Line of least resistance
Why is there a least resistance
Because There is High and Low
There is Always a Down hill
Even if with share prices That is UP

I see it has Looking at least TWO sides
Price is RIGHT and WRONG

If it is Just Right
Then EMH and NO TRENDS

A traded Price IS a difference of opinion
or do you think NOT ?
Do you think that a trade occurs when both Buy or Sell ?

Different Time Horizons are active YES

But that would be for a Discussion

Next Time Someone is Selling Something make sure you buy it
because the price is probably right

Motorway

Stop losses and their effect on price

MrCho

So_Cynical

The Contrarian Averager

all$andnocents

cutz

AlterEgo

skc

Goldmember

motorway

motorway

MrCho

MrCho

MrCho

lukeaye

motorway

lukeaye

kam75

weird

motorway

weird

nomore4s

Commonsense isn't that common

motorway

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