I get questions quite often about how I use stops. Some traders have hard and fast rules such as “If I’m down 25% (or 50% or whatever) on a position I exit immediately.”
I really don’t have such rules. In some cases, having hard stops would have saved me, and in other cases if I had bailed, I would have missed out on big profits.
I usually look to exit a position when my “thesis” is broken.
For instance, if I follow an unusual option trade I will continue to monitor the open interest (does the big trader still hold the trade). If he gets out, then I get out.
If we execute a trade based on a fellow Cabot analyses’ stock pick, then I will exit as soon as he or she recommends selling.
Let’s take a look at some of our current positions:
Talisman has looked absolutely awful recently. No matter what the overall market did, the stock went down. I was very tempted to exit the position. However, we had entered into a bullish trade because of unusual option activity and the big buyer never let up. Therefore, I stuck in the trade and clearly, based on yesterday’s news, it was the right thing to do.
Applied Materials is a position I’m currently heavily debating. For the past 12 months, the stock has continued to make slow and steady new highs and the call buying has been nonstop all the way. ,However, in recent weeks, the stock has stalled. Then in the past two days the stock has sold off aggressively. The only thing holding me back from selling out our positions is the call buyer continues to accumulate January calls—yesterday he bought 5,500 January 25 calls, and today he bought another 2,000 January 21 calls.
Our Rice Energy position has flat out not worked. Yet, I have to say it’s the position I feel best about. This is a real weird situation. The stock seemingly goes down every day, yet the big buyer of October 30 calls just keeps adding to his position. After buying another 8,000 calls yesterday, this big trader now owns approximately 30,000 of these calls. This is a massive position in such a thinly traded stock. If this position turns out to be a failure, I will not be hard on myself because it’s exactly the type of trade that I like to follow and has worked so well in the past.
While I don’t have a hard and fast rule for stops, I have a methodology. However, I have no issue with you having stops, as I feel it’s important for everyone to have their own trading rules and to stick to them.