Ask Colin

How do you execute stops in volatile markets where there is low volume?

My methods of setting stop loss methods are set out in my book Building Wealth in the Stock Market – see pages 198-207. This, of course, is the theory and the practical application of the rules is more an art based on skill that comes from experience. It is difficult to teach, but I can show you the journey you must take to develop that skill from your own experience. The best way I have come across to teach this skill is through lots of practical examples – my stock investment journals on the members website. They are time consuming to prepare, but the process is so important to improving my skills that I keep and publish a journalfor every stock I buy.

You asked specifically about days of high volatility and/or relatively low volume. This raises several important issues:

  1. If the stock is already of some size in terms of capitalisation and free float, my experience is that days of high volatility often also have high volume. Just recently, I sold Bradken. I had no problem selling. Indeed, the buyer snapped up whatever I offered at a price that never appeared on the depth screen (either an undisclosed order or high frequency trader). I have already published a completed journal on that investment on the members website, although it does not touch on this issue in any detail.
  2. However, if the stock is small in capitalisation and free float, so that it is not generally very liquid, then, yes, there can be a serious issue in selling. The major problem is that beginners use automatic stops on stocks that are relatively illiquid. I think this is a recipe for losing money. What happens is that one stop level is crossed and that triggers a further fall as the broker’s software seeks volume at lower prices. That triggers more stops and so on such that there is a downward cascade in the price. Eventually, this is exhausted and one of two things tends to happen:
  3. The price stays down there because there are no buyers to push it up and all sellers have finished. In this case I generally sell as soon as I can sensibly do so, if it has taken out my stop loss, which is not always the case, of course.

  4. The price snaps back to near where the price cascade started and well above my stop loss. In this case, if my stop loss was violated on the cascade, I will monitor the situation closely. What I am looking for is the direction of subsequent price action. If the subsequent price action is sideways to upward, I will hold. If the subsequent price action is downward I will sell.

    I have commented briefly on this issue in a couple of my journals on the members website. In particular, I have spent quite some time in the long journal on Oroton Group on this specific issue. Amalgamated Holdings is another interesting example in this regard, although that was before I was writing up a journalfor all my holdings.

    A suggestion is that members could paper trade my stocks and see what they think they might have done if they had also held them. Members will know what I have done from my website, which is updated as soon as possible after I have bought or sold stocks (Portfolio Disclosure page on the Free website and Portfolio Details page on the Members’ website).