Thursday, July 26, 2012

Price shocks and gaps through stops

Today's price move on UK stock Lamprell shows that even when a proven system flags up a stock for a potential trade, things do not always work out as intended. This stock I had flagged up on the protected Twitter feed on one more than one occasion as a good-looking set up, with the added bonus of a large price gap to potentially fill.

In this case, some news released before the open this morning sent the share price tumbling, opening down over 40% from the previous day's close.

If you were trading this position in the UK via a spread bet with a guaranteed stop in place, then you would have been okay as you would have only lost -1R, being what you would have risked. However, if you did not have such a stop available to you, then you would have incurred a much greater dent to your equity - by my calculation at least -2.5R, depending on how far way you placed your initial stop.

It is these types of price 'shocks' that go against us which we do not want to endure - as trend followers, we want to cut our losses and let our profits run, so that any price shocks are always on the positive side.

It is for this reason that I trade a much smaller position whenever I open a trade where guaranteed stops are not available (such as I did on my Gulf Keystone position I recently opened, and got stopped out of earlier this week), or due to the size of the position you want to trade.

A lot of my recent posts have been concerned about controlling risk when trading, and a price shock such as this is a vivid example of what can happen. There are two more extreme examples here in a previous post.

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