Ask Colin

How do I avoid being shaken out when good stocks suffer sharp falls and then recover?

You mention in your extended question the situation on Fleetwood, where it seems that a small fall triggered stop-loss orders at progressively lower levels. As you say, the sellers were in error, because the stock recovered soon after and went much higher on good news. You suggested that it could have been someone trying to buy cheaply by triggering stop-loss orders.

This last idea is not illegal or unethical. The most memorable example was Baron Rothschild in 1815, when he had advance information on the defeat of Napoleon at Waterloo. He knew that would send British Consols higher once others knew. He was also aware that others might suspect he had advance knowledge. So he started selling. When everyone had seen him selling and started doing the same, he switched to buying and made a killing. It would still be legal today, so long as he was not using information he obtained as an insider This is done every day in the markets today as professionals "run the stops". They guess where they are and go after them.

The key point about Fleetwood and stocks like it is that it is thinly traded. It is simply an unsuitable market to use stop-loss orders on unless you are prepared to accept potentially large slippage (the difference between your stop-loss and the best bid). It would be much better to use some of the alert services to tell you that your stock had hit your stop and you then manage the stop yourself. In such a disorderly market, you may have let the dust settle first. So, it is up to the investors concerned. There is no law against ignorance or stupidity. If they use these stop orders in an inappropriate market, they are going to get punished until they learn.

As for how you can know whether to sell or not in these situations, there is no magic formula. You have your investment or trading plan and you should follow it. My own approach in these situations is that if I get shaken out and have to climb back in again later, the brokerage and slippage costs are a kind of insurance policy against catastrophic loss. The name of the game is to limit losses, but let profits run.

Looking at the lessons from the Fleetwood situation, on my investment plan, I should have sold on the spike down, or on the next day, if I had not known what was happening during that day. I did not own Fleetwood, so I can only comment with hindsight, which you have every right to suspect. If I was watching it during the day, I think I might have sold near the low(unless I considered the market was disorderly on low volume and waited). However, there was no reason from the preceding days to cause me to think it was anywhere near my stop, so I believe I would not have seen the situation until the next morning. Then, I may not have sold, because Fleetwood has spiked down so far and then closed right up where it was before. I think I might have monitored the next day or so. It then traded lower for several days and although it eventually turned around above my stop, I think I would have sold it on what I saw as confirmation of the original signal.

My investment plan calls for me to act on lows, so this is why I say that. However, others have a different plan that calls for action only on closes. If that had been my plan, then I would not have sold Fleetwood. Does that mean I should change my plan? No, because one example proves nothing.

There were other crutches you could have leaned on. For example, volume was not unusually high on that day. The long-term trend line was only touched, not broken and definitely it did not close below the trend line. It was above the 260-day moving average even at the low of the day. And so on. None of these are my plan, but they may be someone else's. These things may have saved them from selling here, but on another occasion, my pan would work the other way versus theirs.

In the final analysis, this question does not worry me much. If I had sold Fleetwood on the days after the spike down, I would have bought back on the new high. I did exactly that in Integrated Group this year. No matter what your plan, these things will happen sometimes. It is part of the game that there is no single tool that works perfectly all the time. The best we can do is to find tools that give us an edge. The rest is money management and controlling losses.