Ask Colin

If a stock falls one cent below your stop and closes above it is this a SIGNIFICANT trough?

To answer this, let me set the scene:

We have an uptrend. There are a series of higher peaks and troughs. The stock makes a new high for the trend. I move my stop up to just below the trough. As a GUIDELINE ONLY, I would put my stop about 2% below the trough, but below a round number. Let's say the previous trough was at $2.58. I would put the stop at about $2.53.

So, now to your scenario - the price has fallen to $2.52 and closed at (say) $2.62 to make the point really clear. I would sell at market next day. The logic is simple - I trade trends. Trends require higher troughs to be intact. I now have a lower trough, so the trend has been violated. Therefore I must sell or I am in a "hope" trade.

Now the trend may reassert itself and go on to make a new high for the trend. At that point I will CONSIDER buying in again as a new trade.

That is what I would do, because of the logic of my trading plan. However, it is not the only possible trading plan. There are many other possible ways to deal with this situation. That is up to each trader/investor to work out for themself. There are no right or wrong answers in this game, except in terms of a given trading plan. If I explained my plan and asked you to follow it and you did not sell, you would be wrong. However, if your plan was different, then the right action in that situation may be different.

For example, you might have a rule which says that sets your stop where I do, but have an extra rule that says the close has to be below your stop. In that case, you would not have sold on your scenario. The implications vis a vis my exit are that you might be saved some sales and re-entries that I incur. On the other hand you might also have some lower exits than I have, depending on what happens after your scenario - the trend reasserts itself or the break is confirmed respectively.

I also look at this in terms of slippage. Sometimes I will have an exit with no slippage - in fact I get out above my stop. However, if your close has to be below the stop, then you would encounter actual slippage more often and it may tend to be larger on average.

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