Ask Colin

How do you deal with a stop-loss violation after a results announcement?

The detailed question was:

I would just like to get your opinion on how you deal with a stop loss violation after a result announcement. Today a stock I own fell well below my stop today but then closed well above it. I am curious on how you deal with such cases and whether you sell immediately if a stock falls through your stop or if you only sell if it closes below your stop. I guess becomes a little more of an issue these days when we see such large swings in share prices on response to results. Appreciate your advice. So you know I have clearly identified this as a shortcoming in my plan and this emails is to assist me on what I do to fix this shortcoming.

I have already answered the question of what I would do - see the question under Stops on the Ask Colin page: What you do if you miss a sell stop signal and by the time you pick it up the share has moved up out of danger? - so I will not repeat what I have already said here.

Actually, in my opinion, you are asking the wrong question - what I would do? This is because what I would do is driven by my investment plan. Your investment plan must be different to mine because you are not me and an investment plan must be tailored to who you are, what you are trying to do and how (the logic of your investment plan).

So, if your stop in general terms is where you are wrong about the investment if the price were to fall there, or close there, whichever you have tested in lots of situations, then you should act on your stop. It sounds to me from your question as though your investment plan is not logically tight enough in the sense that you are not clear on whether your stop is based on the low price of the day or the closing price of the day. I suggest that you need to go back and rethink your plan. The guidelines for doing this are:

  1. Be very clear on what you are expecting to happen once you have a buy signal.
  2. Define that expectation in terms of price action – very precisely, leaving no ambiguity.
  3. Define when that expectation has ceased to happen. That is your stop.
  4. Test your plan on many, many stocks over bull and bear markets.
  5. If your plan tests out OK, then you have the answer to your question. If not, go back to point 1.

This is how you learn. It is not by me telling you what I do or what I think you should do. If that were to be the case, I guarantee that you will abandon the plan once the market has put you under pressure as it has recently in the example you mention.

I hope  this is of assistance on your journey from beginner to good investor. It is not an easy journey, but very rewarding if you stick with it.

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