How to Get Back In When You Are Stopped Out
This article originally appeared in the Ask Jack column on Bidnessetc.com. Each article answered a question submitted by readers.
What do you see as a good approach to re-enter a trade you like? You are short the yen with a target to 150 yen/dollar. You enter at 115, and are stopped at 110. When do you get back in? In 3 weeks? After bouncing some percentage from the last bottom?
This is a good question for at least two reasons. First, the question describes a dilemma faced by almost all traders and usually many times. Second, it addresses one of the most difficult tasks a trader faces.
Let me begin by rephrasing the question in general terms. You have a strong conviction, based on either technical or fundamental considerations, that a specific market or stock will experience a long-term trend in a given direction. Being a disciplined trader, you limit your maximum risk on the trade by using a GTC stop. Your position is then stopped out. The problem is that you still believe in the original trade premise. You are worried about missing a major trend that you correctly anticipated. So how do you get back into the market?
Given this type of situation, many traders will be tempted to reenter the position soon after, and sometimes immediately after, they are stopped out of the trade. They fear that right after stopping them out, the market will maliciously reverse direction, leaving them with a realized loss and the even worse agony of watching prices move in the direction they anticipated all along while they are left empty-handed on the sidelines. Getting right back in will feel good because it will remove the possibility of this painful scenario and provide another opportunity to profit from the original trade idea. But, as William Eckhardt said, “What feels good is often the wrong thing to do.” More often than not, giving in to the temptation to jump back into stopped-out trades will lead to repeated losses on the same trade idea.
Granted that jumping right back in is usually not a good idea, but the question remains: What reentry strategy can you employ to eventually get back into a trade you still believe in? Let’s begin with the easier case where the market continues to move against your original idea after you have been stopped out—that is, the stop saved you money. This is the easier case because you will often be reentering at a more favorable level than you exited. There are two basic approaches you can use here. First, assuming a long position for illustration, you can identify an anticipated support area below the market for reentry. This support area could be based on prior highs and lows, Fibonacci retracement levels, swing move objectives, or whatever approach you favor. A new money management stop would, of course, accompany such a new position. Second, you could define a point above the market that would suggest a reversal back to the longer-term trend and reenter the market with a buy stop at that point and a new protective stop. You could combine these two approaches by using an OCO CTC order to enter on a limit at the lower point or on a stop at the higher point. Combining the two approaches will guarantee reentry, often at a more favorable price than the stop liquidation point of the original trade (always a better price in the case of the limit reentry and sometimes in the case of the stop reentry).
The more difficult situation however, is the one in which the market does indeed reverse back to the original trend not long after you are stopped out. Now reentry will involve getting back in at a worse price than the price at which the original trade was liquidated. Here, the natural inclination will be to reenter on a pullback (again, assuming a long position for illustration) so that the original stop exit does not end up being a mistake. Once again, the tendency to choose the approach that will feel the best will usually be the wrong decision. If the market does not witness the hoped-for pullback, the trade opportunity will be missed altogether, and, arguably, the best opportunities will not accommodate the trader’s pullback entry price.
Traders should not try to define a point that will provide an entry that will feel good (i.e., a reentry at the same or more favorable price than the original stop liquidation point); instead, traders should focus on defining a point at which the original position could be reentered with a meaningful, well-defined and acceptable protective stop, even if this point is at a much worse level than the original liquidation price. “Meaningful” implies that the protective stop point is one that the trader acknowledges would indicate a probable renewed failure of the long-term trade. “Acceptable” means that the risk implied by the meaningful stop is one that is within the trader’s normal tolerance for a loss on a single trade.
One approach that fulfills the above conditions is reentering on a narrow consolidation, anticipating a breakout in the direction of the assumed long-term trend, with a protective stop on the opposite side of this consolidation. One caveat is that the stop should not be placed right below the consolidation (assuming a long position) but should provide some extra room, as marginal breakouts of consolidations are very common. Such a consolidation may form at a much worse price (i.e., higher price assuming a long position) than the price at which the trader was originally stopped out. But that consideration is irrelevant.
The relevant question is not what would make you feel good but rather what is the right decision. If you believe the market is going much higher and is likely to break out on the upside of an ongoing consolidation, then getting back in at a much worse price should not stop you from getting back into the trade—again, as long as you can define a meaningful, well-defined and acceptable protective stop point.
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