When to Ignore Good Advice
By Jeff Clark
June 21, 2007
Early this month, in the midst of the market's three-day drop, I told S&A Short Report readers to ignore the stop we set on our Home Depot calls…
I can only imagine what our customer service department had to contend with after that.
Secretly, I was saying to myself, "What good is a stop order if you don't stick to it?"
Most of the editors at Stansberry & Associates are long-term, value-oriented folks. They are truly gifted at what they do. And when they set a stop order on a stock they recommend, then you darn well better stick to it.
But I'm a trader. I'm the redheaded stepchild on the S&A editorial staff. So I'm a bit more flexible with the concept of stop orders.
Three weeks ago, I told subscribers to buy the Home Depot August 40 call options. They were trading at $0.90 at the time, and I said that buying them up to $1.30 offered a good risk/reward setup. I also said to set the initial stop price (the price at which we should cut our losses) at $0.60.
But I changed my mind as the market traded lower and Home Depot (HD) headed lower as well. HD was still trading higher than when we first recommended the trade, and I argued it didn't make sense to stop out of the position simply because we lost time premium on the options.
In fact, here is word for word the exact reason for my original recommendation…
The Bollinger bands [which define a stock's trading range] are narrower now than at anytime over the past year. That means that HD is headed for a sharp, sudden price spike. And, my bet is it will spike higher.
Even during the brief sell off we saw last week, the technical condition that got us into the Home Depot trade never changed. So I told subscribers to ignore the stop and stick with the trade.
Yesterday, that analysis paid off. We sold half the position for a 75% profit as HD spiked higher on the news of the sale of its Home Supply division.
The point to all of this is that setting stop prices is useful for investors in that it limits the potential loss in an erroneous trade. But for traders, when the conditions that led to the trade in the first place remain intact, then stop orders need to be a bit more flexible.
If Home Depot had violated the pattern that got us into the trade in the first place, then I would have stuck to the stop order, taken my loss, and moved on. But, since the technical condition remained the same and all that happened was we lost some value in the time premium, we stuck with the trade and turned a small loss into a 75% profit.
Best regards and good trading,
Jeff Clark
