December 8, 2010 | In: Energy, Opinion

Sell on Stop: A Dangerous Game

I bought some HOD‘s at $8.23 a piece last week. I thought it was a good price, until, of course, GS thought otherwise. As you may probably know, oil broke the $90 level in the span of a few days, thanks to GS’s prediction of oil hitting $110 next year, and $120 by the end of 2012, hinting that oil is undervalued at the current price level.

The problem was that I really needed the money I invested in those HODs (which is breaking the number one rule when trading, never play with money that you need), so I put a Sell on Stop to minimize my losses, the sell on stop was first set to $7.50. For crazy reasons (live and learn), I upped my limit to $7.65 two days ago (Monday evening), because the stock was going up (oil started to retreat a bit), and I thought that was better protection for me. Wrong…

For reasons only known to God, oil went up like crazy in the early morning of Tuesday, driving the stock below my threshold of $7.65, I saw that oil was going up crazily before the market opened, yet, because I really needed the money, I was sentimental and I didn’t change my threshold to lower. Additionally, I thought I was trading against the trend even before the GS news when I bought the HODs. I was very emotional (Being emotional is one of the top trading mistakes). How can you not be emotional when you need the money? I used to make money on every trade, and I started losing money on some trades only when I started actually needing the money!

Anyway, as I stated, the stock dropped down considerably in the morning, take a look at the following image (courtesy Google Finance):

HOD Dropping to $7.55

So what happened because there was a lot of panic in bear oil ETFs because of the spike in the morning, the stock dropped to the $7.55 level. Needless to say, my trade was triggered, but not at the $7.65 level of course, it was triggered at the $7.55. Now, of course, the stock went up over the $7.90 level by the end of day, as oil kept on going down.

It was a costly and a stressful experience, but I learned some excellent lessons from it:

- Never, ever buy any stock when you need the money. Oddly enough it was something that I have warned against in my little explanation on HOU and HOD.
- Set your Sell on Stop to a very low value: Your sell on stop should only be triggered when the stock reaches a price that is totally unacceptable to you. Stocks fluctuate, and, unless you’re day trading, you should accept this fact.
- Only increase your Sell on Stop when you are making money on the stock, not when you are still in the losing area: Let’s take my trade as an example. As the stock went up while I was still losing money, I upped my Sell on Stop threshold, to minimize my losses, but by doing so, I increased the risk that if the stock goes down even less than I accounted for earlier, I would lose money. Now the wise thing to do was to wait for the stock to go above my trading price, let’s say to $8.50, and then set a threshold at $8.40, and then increase my threshold as the stock goes up. This way I will increase my earnings on the stock (by increasing the threshold as the stock goes up), and minimize my losses (by setting a very low threshold if I’m losing money on the stock).
- Finally, something that I have yet to learn, never ever be emotional with stocks. Although it’s hard not to do that when you’re losing/making money, doing so will be even harder when you need the money. Always play with risk money (money that you don’t need to fulfill your different financial obligations and won’t adversely affect your lifestyle should you lose it). Accepting loss as a necessary part of the game and practice will make you perfect.

2 Responses to Sell on Stop: A Dangerous Game

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Fear and Greed: The Two Characteristics of Unsuccessful Stock Investors « Fadi El-Eter

April 29th, 2011 at 3:37 pm

[...] a reasonable expectation from the stock (for example, I will be happy with a 2% profit) – Create a sell on stop condition on your winning stocks if you intend to be a bit greedy. In other words, let your [...]

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Are Penny Stocks Safe? « Fadi El-Eter

January 5th, 2012 at 8:06 pm

[...] you have a lot of tools to help you limit your losses: You can buy married puts, you can create a sell on stop order, you can do a lot of things… None of these tools are available for you when [...]

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