Stops Too Tight | Podcast Episode #205

0:07
Hey, I’m Ryan Mallory, and this is my swing trading, the stock market podcast. I’m here to teach you how to trade in a complex, ever changing world of finance. Learn what it means to trade profitably and consistently, managing risk, avoiding the pitfalls of trading, and most importantly, to let those winners run wild.

0:25
You can succeed at the stock market, and I’m ready to show you how. Hey, everybody, this is Ryan Mallory with Swing trade in the stock market in. Today’s episode is gonna be about, can you have a stop loss that’s too tight? Is there such a thing? I mean, you would think that the tighter the stop loss, the better the opportunity is to double, triple, or even quadruple the reward that you get from the amount risk.

0:50
But is there a certain point that you reach on a stop loss where you’re just like, nah, it’s too tight, you can’t trade like that. That’s the question that I’m going to grapple with today as well as short-term patterns versus long term patterns. We’re gonna talk about all of that.

1:06
The email, and I’ll go ahead and just jump right into it here comes from a guy that I’m going to call, I guess it’s not really a guy name, but we’ll call him anyways, Florence. Lawrence writes, let me start off by saying thank you. You mentioned multiple times in your podcast that you didn’t have a mentor growing up to learn about stocks.

1:24
I think it’s safe to say that you have become a mentor to a whole lot of people listening to your podcast, including me. I learned a lot by listening through your podcast and also being subscribed to the SharePlanner for over a year now. Well, thank you very much. That’s one thing that really does mean a lot to me. I feel like I do have a little bit of a gift for teaching and being able to mentor you guys in any shape, form, or fashion really does mean a lot to me.

1:46
He goes on to say, I have two questions for you. Being part of SharePlanner and listening to most of your podcasts, I certainly understand that a good trade, there needs to be a good risk reward ratio. However, sometimes I find setups that have a great risk-reward ratio, but the risk or stop loss would be only 1 to 2% at its closest support or nearest low.

2:07
Is this enough to let the stock do its work, or is it better to find a different setup with a stop loss closer to the 5% range to let the stock have enough room for it to do its thing? There’s sometimes really nice setups out there, but there’s only 1 to 2% stop loss where there is so little room you can be out of the trade within hours for it just to go up 10% in the following days and weeks.

2:29
My second question is about patterns. From your experience, is it better to find a pattern? That has been developing for a longer period of time or a shorter period of time. Example, is it better to set up for a stock breaking out of an inverse head and shoulders pattern that’s been developing over the past couple of months or just the past couple of weeks.

2:50
If this doesn’t make your podcast, it’s OK, but I’m curious to hear what you think about my questions. Thanks for all that you do. Regards Florence. Well, it did make the podcast and we’re going to dissect your questions in depth, but first, what am I drinking? Well, I’ve seen this bottle many, many times over the past couple of years.

3:09
It’s called Blacken. Probably some of you guys have seen it too. I’ve never been inclined to buy it. It’s a whiskey. It’s not a bourbon. It’s a blend of straight whiskey finished in black brandy caskets. And I said, you know what, I’ll get to it one day. It’s just really not at the top of my list or something I need to get.

3:26
If I can get a sample of it, fine. But this thing really impresses me. I mean, it’s a really nice dark color to the nose. There’s not a lot of smells to it, but it tastes the subtle fruitiness to it. But it comes in hot, it stays hot, it lingers hot, and you would think, OK, that sounds like something like a knob Creek 9 year old granddad 114, which are better for old fashion, but no, this thing is amazing neat.

3:49
I mean, I love this stuff. This is really, really good and I’m shocked that it’s so good. And there’s a backstory about how, you know, they put it into these casks and they play metallica music at full volume and it vibrates the whiskey inside the barrels. Look, I don’t know what they do to make it taste this good, but if that’s what it takes, man, play on, because this is good stuff.

4:11
I mean, really good, highly recommend it, everyday sipper. I’m giving it an 8.3. It’s like when you taste a piece of pizza, right? And it’s a good piece of pizza. And it burns the roof of your mouth. You’re not focused on that. You’re just focused on the fact that you just had an amazing, amazing piece of pizza, and that’s kind of like what it is with this whiskey.

4:32
It’s a good whiskey. It’s one of the best non-bourbons I’ve ever drank and I think it’s really good. Like I said, 8.3 solid solid drink. Probably one of the best parts about it is how long the flavor lingers and it’s not a bad aftertaste or anything. It’s a good aftertaste that lingers, which means you don’t have to drink it that fast to enjoy it.

4:52
Now, let’s get back to Florence’s email. He talks about a 1 to 2% stop loss, and there’s been plenty of times in my past where I’ve used 1 to 2% stop losses, but I’ll tell you this. I don’t think a 1 to 2% stop loss is all that effective. It’s not that I will never use a 1 or 2% stop loss, and if it comes to like a ETF of like spy or or the NASDAQ, maybe there are situations where like a 2% stop loss would be warranted.

5:19
But I have learned more and more over time that Your potential for getting stopped out is greatly increased and The thing is, is intraday movements. You can have a 1 or 2% decline and then all of a sudden the stock finishes green or the ETF finishes green, and it didn’t necessarily kill your trade.

5:37
Yes, it might have broken below a critical support level intraday, but by the time the close came around, it was already back above key support. And so 1 to 2% stop losses will put you at risk for getting stopped out quite early, only see the stock rebound.

5:54
Now, you start going into like the 4 to 6% range and you have a little bit more wiggle room there. You’re still being able to keep the risk reward at a pretty solid ratio there. If you can get 10 to 15% off of the trade, that’s going to be able to justify a 4 to 6% stop loss.

6:12
But if you start getting in the 10 to 15% range, you can say, well, Ryan, then you’re giving yourself even more room to not get stopped auto erroneously. Yes, but then there’s like a denim margin of returns when you start doing that. You could say the same thing about 50% stop loss, but you take a 50% stop loss, I mean, things are really falling apart by the time it gets to that point.

6:31
But 4 to 6% is pretty good because it still gives yourself a lot of wiggle room and if you’re trading your large caps, yes, you can still get stopped out in a similar fashion to you’re using a 1 to 2% stop loss, but the frequency of that happening is greatly reduced unless you’re trading, you know, like cryptos or altcoins or something like that and 5 to 6%.

6:52
Can just happen within like a 10 minute period. But I think if you’re trading stocks like that are well valued on the Russell 2000 or, you know, on the NASDAQ 100 or the S&P 500, those 4 to 6% stop losses are pretty solid.

7:07
And then when you break below it, you’re gonna feel much more comfortable about getting out of them. 1 to 2% stop off it sounds good from a risk reward standpoint because if you’re trying to get 8% on a stock. A 1% stop off is gonna be amazing because you’re gonna get a 8 to 1 return if that trade plays out in your favor.

7:25
However, the likelihood of success goes down dramatically. So what I would probably say to do is try to find another support level and have multiple layers of support is even better on a trade. If you have a key moving average at let’s say like the 20 day moving average is like, look, OK, I can put my stop loss below there, but that’s only like 2% away from the current price action.

7:47
OK, well then maybe find another key support level and let’s say there’s a rising trend line right underneath that 20 day moving average of, you know, let’s say 1 or 2% below that. So then you, you’ve got two support levels that are very significant within like a 4% range of each other.

8:03
Then you’re only increasing the chances that your stock is going to probably bounce off of one of those two support levels before you get stocked out. And so having multiple layers of support is really, really good for your trades. The more support levels underneath your entry price and above where you eventually put your stop loss at, the better.

8:22
Because you’re increasing your odds that the stock will not break and hit your stock loss. So, If you can’t find another support level that is nearby, then I would just probably start looking at like a 30 minute chart or an hourly try and, and try to find some intraday support as well, because even if it’s just intraday support, that’s still support that it may bounce off of.

8:43
But you wanna give yourself a little bit of room, enough room at least to where if it takes a quick dip intraday, it’s not gonna stop you out. Now, if you’re insistent on Using like a 1 to 2% stop loss. Another thing that you can do is take the strategy that I just outlined about using a stop loss on an intraday basis, that might be 4 or 5% below your current entry price.

9:06
But then use a stop loss on a closing basis, saying, look, I’m not going to get out at this 1 or 2% stop loss if it breaks at intraday, but if it closes below it, I’ll get out of it. Now, if it breaks below the stop loss, I have 4 or 5% down below on an intraday basis, I’m gonna get out at that level.

9:22
And so you have two different scenarios there that you can play with because if you do use that 1 to 2% stop loss. You’re greatly increasing the chances of getting stopped out intraday, only see that stock go right back up, just like Florence outlined in his email.

9:38
So he’s been there before. He’s dealt with those kinds of moves and I have too, and it’s, it’s frustrating because there’s been so many times in my life where I can get sucked into a trade and it’s like, oh man, look, I can use a 2% stop offs. And there may be certain trades that warrant a 2% stop loss.

9:53
There just maybe be gobs and gobs and gobs of support that says, hey, you can get away with this. But If we’re just looking at the average trade, 2% stop losses can be kind of tight. The other thing that I will do too is if it’s a 2% stop off and there’s not a support level a little further down, I’ll just give the stock a little bit more room to run.

10:14
Maybe I’ll get that extra confirmation instead of just waiting for the breakout of a bull flag or the bounce that takes the price out of this base that has been forming. Maybe I’ll, I’ll wait for it to break another trend line that has been acting as resistance. I will look for that extra confirmation knowing that I have a little bit of wiggle room here because the stop loss is so close.

10:34
Now, the second question is about patterns. He’s talking about patterns that form over a longer period of time versus a shorter period of time. And so he, he uses the example of an inverse head and shoulders pattern that has developed over the past couple of months or the past couple of weeks or days. The longer the pattern, the better. And the best example of that is just recently here with the Russell 2000.

10:53
This thing has been trading in a sideways channel since February of this past year. Actually, I think it’s late January that it started this pattern and has been trading sideways and it keeps bouncing off the top end. And bouncing off of the lower end and it just can’t break through, it just kept trading sideways.

11:10
And then eventually it broke out, but it was a very long pattern. It was like a 10 month long pattern that eventually broke out to the upside. I actually took the trade and it’s gone higher ever since. It’s been an amazing breakout so far. And as another example, you got Netflix.

11:27
Netflix had been trading in a Sideways channel for over a year, and then it broke out and it has really broken out in an amazing fashion. People have made a lot of money off of that breakout. So the longer the channel or the longer the pattern tends to be the better.

11:42
It’s just like if you’re looking at a pattern on a one minute chart versus a daily chart. What chart is going to have more credibility? It’s going to be the daily chart because the one minute chart, there’s not as much conviction in a one minute chart and the patterns that are developing there versus what you’re going to see on a daily chart or even a weekly chart or a monthly chart.

12:01
So, the bigger the time frame, the better, the longer the time frame, whether it’s, you know, 6 or 8 months, that’s going to be a lot better than a chart pattern that has only formed over the last couple of weeks. And 2, you want to remember as well that patterns work better in some conditions than others.

12:20
Like for instance, we’ve been in this bull market rally that’s been going on for like 10 or 11 years now. Head and shoulders patterns have been some of the worst patterns to trade from a short standpoint. In fact, shorting’s been awful too. I mean, there’s been periods where shorting works, but. By and large, shorting has not been effective.

12:37
Head and shoulders patterns tend to see massive bounces off of their necklines. So you also want to keep in mind, and I know this isn’t part of the question, but I figured I would throw that in there as well. Be mindful of the patterns that you’re trading in the type of markets that you’re trading in. Like over the last month, where the NASDAQ has gone up like some 10 straight days before finally having a red day today, I wouldn’t touch a head and shoulders pattern.

13:00
And so that’s part of knowing the kind of market that you’re in. I don’t care what kind of patterns are forming on the short side. I wouldn’t be looking to get short on a stock that, especially like a tech stock that is just continuing to see the broader index, its sector and its industry, see rapid price increasements each and every day.

13:18
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13:34
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13:53
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14:10
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14:26
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