Cut It or Let It Run?: Picking Proper Entries and Stop Losses

• Posted by Greg Harmon
• on October 19th, 2010

The question comes up often, “How do I decide to cut a losing position if I still think it has good upside?”  The correct response is “You should never be in that situation.”

Avoiding it lies in selecting the proper stop loss level and then picking the right entry. Let me illustrate with an example. Here is a chart of Solarfun Power (ticker: $SOLF) from my watch list going into trading Monday. Looking at this chart I had picked this as a short opportunity if it broke below the 11.00 support area from September 2nd, as it was already under a falling 50 day Simple Moving Average (SMA), and set a target of 9.89, the 100 day SMA.

Selecting the Proper Stop Loss Level

I chose a stop loss of 11.07, the Friday closing price.  The stock already had some downward momentum, so even though it was a tight stop it was significant, in that it meant that the 11.00 support had been breach and then retaken, perhaps reversing the downside momentum if the stop were to be hit.  This created a reward-risk ratio of 15.86 ({11.00-9.89}/.07), very high.

Picking the Right Entry

All that analysis assumed that I could get into the stock at near 11.00 early Monday. Now look at what happened at the open.

The stock opened at 10.99 and immediately traded down to 10.60 before I could get filled. Even though I still saw potential for a 71 cent downside move, over 6.7% move in the stock price, this moved the reward-risk ratio down to 1.51, one tenth of the premarket analysis. To enter this trade at 10.60 would leave you asking that question above. There is too much downside risk in the trade back to the 11.07 stop. If I entered a short position at 10.60 I would be in that situation, when it quickly backed up to 10.90, down 30 cents on my trade, wondering if I should cut it or hang on.  Waiting on a better reward-risk ratio or moving on to another opportunity are a better idea.

Find the opportunity, select the right stop loss, and pick the proper entry and you will not be scratching your head about your trades.  Trade’m well.

If you like what you see above sign up for deeper analysis and trading strategy by using the Get Premium button above. As always you can see details of individual charts and more on my StockTwits page.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

blog comments powered by Disqus