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Stop Orders Don’t Work – Latest Example: Priceline

August 09, 2012 | About:
You were sitting pretty with a big gain in PCLN @ $680 per share just a couple of days ago. Your gut told you there was a lot of risk so you entered that oft-recommended stop-sell order to protect yourself against giving very much back.

A stop-loss (a.k.a. stop-sell) order triggers when the specified stock price touches a minimum price under where it was trading when you entered the order. There are two types of stop orders. Some convert instantly to ‘market’ orders when activated and others those that turn into ‘sell-limit’ orders once they are triggered.

Let’s discuss what would have occurred Wednesday depending on the type of stop you had entered. Assume you put in a 6% trailing stop when PCLN was quoted at $680. That would have triggered on a $40.80 dip to $639.20 or below (assuming no limit price was indicated).

You felt you had unlimited upside with just 6% downside risk. Wrong. Because PCLN opened at $575.10 your sell-stop order morphed into a market order to sell. If you were lucky you took ‘just’ a $104.90 hit from the previous day’s close.

The gap-down opening took away your chance to get out with the maximum 6% retracement you figured to absorb. Ouch.

pcln-aug-2-8-2012-source-yahoo-finance.j

Suppose you understood the distinction and ‘wisely’ put in a stop-limit at that $639.20 (-6%) level. Your stop-limit order would have activated just like in the first example. Unlike that unlucky earlier trader, you wouldn’t have been instantly sold out at $575.10 or less. Your now-triggered order would still be sitting, live but unexecuted, awaiting a rebound of more than 11% to get back to the specified limit minimum of $639.20.

Priceline closed at $562.32 without much intraday bouncing. So…you’d still be long PCLN with a one-day paper loss of $117.48 or (-17.28%).

Whether you used a stop-sell (no limit) or a stop-limit order; you ended up with a result you weren’t prepared for.

The two effective ways you could have reduced or eliminated risk?

If you owned a round lot (any multiple of 100 shares) you could have bought a PCLN put option(s). That form of term insurance would have looked good today if you’d bought it while the shares were still flying high.

The elegant way to have avoided the big drop? You could simply have sold your shares at $680 on Tuesday. That would have locked in your gain while eliminating any further upside.

Sometimes the old-fashioned way is still best.

Disclosure: No position

About the author:

Dr. Paul Price
http://www.RealMoneyPro.com
http://www.TalkMarkets.com

Visit Dr. Paul Price's Website


Rating: 3.4/5 (11 votes)

Comments

Dr. Paul Price
Dr. Paul Price premium member - 2 years ago


Trying to insure against loss using stop orders is like having fire insurance on your house that would pay off "most of the time" if your house burned down.

I doubt many people would be happy with homeowners' policies like that.
Cogitator99
Cogitator99 - 2 years ago
good one.
Peticolas
Peticolas - 2 years ago
You can have a gap opening any time but it's far more likely after earnings announcement. If you're not comfortable with that, you should sell before earnings announcement. Of course, the other solution is to have a diversified portfolio. Fossil jumped 32% when earnings beat expectations last week. If you held both those stocks in a portfolio, you'd be happy at the end of the week.

I only use stop loss orders for stocks I've decided to sell. Then I will use a 3% trailing stop loss if the stock has been trending upward. I would sell before earnings announcement though.

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