Ask Colin

When setting a stop-loss below the last significant trough in an uptrend, do you ignore an extreme spike down?

Generally no. I would use the low of a spike downward because that was where buying came in to arrest selling pressure on that occasion. That is where support was last time. If that level breaks, it is significant because something has changed.

If we set the stop-loss at a higher level, it is possible that we get stopped out and the price slips further toward the old support before turning around and rallying without us on board. The trend would still be intact so long as that previous trough was not broken on the downside - we would have a higher, or at worst equal, trough.

That is my view. There are other views. Some might well ignore the extreme low, but I do not understand the logic behind doing that, except that they do not want to risk so much of their profit. There is also the candlestick analysis view, which is that the open and close are more important than the high and low of a bar. So, they might set the stop-loss just below the real body of the candle.

The risk is that you grasp at this to avoid putting your stop where it should be.

The best advice I can give you is that before using any method of setting a stop, you must test it on lots and lots of stocks over the full bull-bear market cycle, before using it. It is only in this way that you will understand how it works and what can happen, so you are prepared. Rest assured the market will put you under pressure sooner than later and unless  you know deeply that your stops are solidly based on testing, you will be shaken out at a loss time and time again.

Keyword: