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Today Monsato moved down by 10.4%, which takes our 2 day total to 13.9% profit.
Catching moves like this is exciting, and scary all at the same time. It is very tempting for many novice traders to become greedy, thinking that the money train is unstoppable. The other thing that can happen psychologically is for traders to forget their profit targets, technical analysis, and trailing stops, and they don’t allow the profits to run.
Owning or shorting high beta stocks (highly volatile) stocks, or low beta stocks in a highly volatile market requires a solid trading plan. It requires you as the trader to remove your emotions from your trading, and allow the chart to steer you in the right direction. Of course, this is incredibly dificult to do even for experienced traders.
Enter The Trailing Stop
If you’ve followed any of my stock picks, you’ve heard me talk about trailing stops. I’m going to show you three different methods of placing trailing stops, and use MON as a trading example for all three. I will follow this trade until it either reaches the profit goals I set out in in the original trade plan (between $52.60 and $45.28), or, until each method gets stopped out.
New Method Just Added – The Chandelier Stop
I’m updating this post almost a year later with a new trailing stop method that I learned in an Ino.Tv workshop from Charles La Beau, entitled “A New Look at Exit Strategies.”
I did not follow Monsanto with this strategy, but I have posted a detailed video on how to use this very profitable exit strategy, and a free software tool to help you implement it. Check out my article “How To Sell Stocks For a Profit: A Tool That Shows You Exactly When To Sell”
Method 1 – Using Support and Resistance Levels
In this case, Monsato is in a clear downtrend, and we have shorted the stock. To find a valid traling stop, we’re going to look for overhead resistance and set the stop a small amount (I like 3%) above that price level. Then, as the trade unfolds, the trailing stop can be moved down to lower resistance levels once price has dropped below these levels.
On the chart I have drawn in two areas of over head resistance that Monsato will run into during any counter trend rally. Resistance 2 is at $97.39, which would have been the area to use when we opened the trade. Now that the trade has gone below Resistance 1 at $87.54, we can use the old resistance as support for our trailing stop.
Using this method, I would recommend setting a trailing stop at $90.17, 3% above Resistance 1.
Method 2 – Using Fibonacci Retracements as areas of support / resistance
If you are unfamiliar with Fibonacci technical analyis tools, here is a great article on investopedia.
I use Track N’ Trade High Finance for my fibonacci analsysis. In this case, since we are in a down market, I have drawn a fibnacci ruler starting at the highs May and ending a the lows 3 weeks ago.
As you can see, the fibonacci retracements uncover some very nice areas of support and resistance. In this case, we would have set the original stop at 3% above the level 2 resistance, and now we would move it to 3% above the level 1 resiteance area of $85.24 for a trailing stop of $87.80
Method 3 – Using the Parabolic SAR.
SAR stands for "Stop and Reversal," and the Parabolic SAR is a systematic formula for settings stops in strong trending markets. When combines with the DMI or Aroon indicator (which measure trend quality), the Parabolic SAR can be very effective at providing sell signals.
Trading with the Parabolic SAR is very simple.
- If the trend is up, buy when the indicator moves below the price
- If the trend is down, sell with the indicator moves above the price
On the chart below, you will see the Parabolic SAR displayed as red dots that flow above or below the current price of the stock. Take a look just above the yellow arrow and you will see a red dot at the $97.20 level. You will also see the current reading for the Parabolic SAR is 68.07, which in fact would be a signal to buy, or in our case, close our short postion.
This is actually a false buy signal for 2 reasons. The first is that this is a weekly chart, and we haven’t finished this trading week out yet (which is why I’m using the previous reading as our trailing stop point). The second is because over the past 2 weeks, we’ve seen a short whipsaw in the overall trend. the Parabolic SAR doesn’t work nearly as well in sideways trending or exteremly volatile markets. When combined with the other indicators, we should see this market go down, and the Parabolic SAR will then provide accurate trailing stops.
For this example, the level of $97.20 is the last level where price was below the SAR, so that’s what we’ll use as our new support level / trailing stop @ 100.11
Summary
As you can see, each of these methods provides different levels of trailing stops, and methods for adjusting them as the trade develops. Overall I would say which ever system that you are most comfortable with utilizing, and most accurately fits in with your level of risk tolerance. In this example, the fibonacci retracements provide the lowes risk, and the Paraboilc SAR the greatest risk. We’ll see how well each system performs as I follow this trade each day.
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