The pain for traders is the loss beyond control or expectation. Successful traders have a habit of limiting the size of losses, such that even many losses are incurred, they will not affect their capital for future investment. A typical method to limit a loss is to set a stop loss order, where any price movement below a particular price, the order will be executed. To illustrate, if a trader set a (sell) stop loss order at $1.00, the order will be filled if the price goes below $1.00. In other words, he could be filled in between $0.95 and $0.00. Usually, he will be filled in at $0.95 as the stock price comes down.
On 16 Jul 09, I witnessed 2 counters that even a stop loss order would not be able to execute at the expected price, which means a trader would have to swallow a loss larger than he should take. The 2 counters are Xtep and Orient Overseas, both listed in Hong Kong Stock Exchange.
Xtep
Taking a look at Xtep, you can see a big red bar on 16 Jul 09. The unusual scene is that the stock price of the following day, which is the 17 Jul 09, was not affected by the big drop in price. On a closer look at the 30 min chart reveals that the big drop in price occurred only in the final 30 minutes of the market. I was unable to playback and view the 1 min or even the 5 min charts to ascertain if the stock has gap down.
Here is the problem: If the stock price has fallen “step by step” (from $3.64 to $3.63 to $3.62 to …), the stop loss order would have worked perfectly to limit the loss. However, if the stock gap down way below the stop loss order, the trader would suffer a greater loss. I shall provide the figures to elaborate:
The trader got in this counter at $3.64 and placed a stop loss order at $3.34. If the stock price fell step by step, his order will be executed at $3.33. If the stock price gap down to $3, he will have his order filled at $3. The former will result in a 8% loss while the latter will suffer a 17.5% loss.
The next counter is Orient Overseas:
Orient Overseas (click to enlarge)
This is almost an identical situation. Supposed the trader got the contract at $33.15 and immediately set a stop loss limit at $30.45. Likewise, if the stock has gap down to $21, he will suffer a 36.6% instead of an 8% loss. Taking such a bigger than desired loss will affect the long term performance of the trader.
Luckily, I have not traded these 2 counters but this incident have me realized another pitfall of trading. It is a Black Swan of trading – a rare event but of siginficant impact when it happens. One way to defend against this Black Swan is to make guaranteed stop loss orders with the broker. However, not all brokers offer such service. Guaranteed stop loss orders as the name suggests, will ensure your stop loss order is filled at your stated price or at least within a few stops from it. Of course such orders do not come free and you will have to pay a little more commission for it. Right now, I only know IG Markets has guaranteed stop loss order service. Let me know if you know of other brokers that provides too.
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