By Chuck LeBeau
Watching the bank stocks this week was like watching a yo-yo. After six weeks of impressive gains, during which we saw Bank of America (BAC), Wells Fargo (WFC), and Citigroup (C) gain 238%, 106% and 255% respectively, we started the week with big declines. For example Bank of America lost 24% of its value on Monday. This alarming loss was followed by a Tuesday rally of 9% , a Wednesday loss of almost 6% and a Thursday rally of almost 7%. Many other banking stocks were equally as athletic.
While volatile markets such as these are the most challenging environment for setting protective stops, they can also be the most rewarding if you manage to hold on and avoid the dreaded “whipsaw”. So how does one determine the optimal stop price; one that will provide adequate protection while limiting the chances of being whipsawed? Two key factors to consider are the current trading range for a stock and the strength and direction of its current trend. We want to place our stop just outside the current trading range, so that it would only be triggered as the result of “abnormal” price weakness. We also need to take into account the direction and strength of the current trend. The logic is to adjust the stops further away from prices in a strong uptrend, were the opportunity cost of whipsaw may be high, thus giving the stock more room to run.
For a sideways or downward moving stock, where the opportunity cost of a whipsaw is lower, we want to tighten the stop to better protect our capital. Following this strategy, Monday’s trailing stops would have been set unusually low as the financial stocks were coming off a strong but volatile uptrend. As the week progressed, we would begin tightening our stops as the uptrend ended and the stock’s primary direction became unclear. This process may sound complicated but there are helpful services such as SmartStops.net that incorporate this logic in the stops they calculate and publish. And in fact, the SmartStops for BAC, WSF and C were all set quite low on Monday and successfully avoided any whipsaw.
In spite of banking stocks and many other stocks posting earnings this week that were well above estimates, the market remains uncomfortable with the recent gains and continues to be subject to severe corrections. Investors would be well advised to protect recent gains with trailing stops while hoping that any of the anticipated corrections prove to be short lived. Caution continues to be the order of the day.
Note: SmartStop alert prices change daily. For up to date daily alerts visit www.SmartStops.net.
Apr 27, 2009
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