The New Sell and Sell Short: How to Take Profits, Cut Losses, and Benefit from Price Declines, Expanded Second Edition

A BAD PLACE

The worst misconception about stops is that one should place them on long positions immediately below the latest low. This idea has been around for a long time and became very popular because it is simple and does not require much thought. Even I took this bait early in my trading career and passed it on to others—until reality hit me on the head.

The trouble with such stops is that markets very often trace out double bottoms, with the second bottom slightly lower than the first. I could fill a book with charts showing this pattern. The level immediately below the latest low is where amateurs cut and run, while professionals tend to buy.

Figure 5.1 CPWR daily

Good trades tend to come together slowly, and this was certainly the case with CPWR. As it slid in July and August, it created multiple bullish divergences, culminating in the bullish divergence of MACD Lines in August. It reached the low of 7.46 at point A in August. Any trader who bought and put his stop “a penny below the latest low” got tossed out in September, when the stock briefly fell to 7.44 at point B. The question at the right edge is this: where will you put your stop if you buy here?

Whenever prices approach a bottom area, I become alert to the possibility that they could penetrate to a lower low. If prices fall to a new low, while the indicators fall to a more shallow low, creating a bullish ...