“How come you don’t use trailing stops?” asked one reader.
This was at our Total Wealth Symposium two weeks ago.
“They don’t work for my strategy,” I replied.
Understand that I’ve gotten asked this question several times now, and every time I tell people I don’t use trailing stops, they’re shocked.
You see, to me, trailing stops are outdated. They worked when markets were run by humans and bid-ask spreads were wider.
But today, computer programs and algorithms run the market. And bid-ask spreads are sometimes as little as one-tenth of a penny.
Beyond that, there’s virtually no trading in some stocks except at the open and close.
I’ll show you why these different things make trailing stops outdated, but first, let me explain what a trailing stop does…
Trading at the Speed of Light
A trailing stop is an order to sell a stock when it drops by a certain percentage.
For example, many people will put a trailing stop to sell a stock when it falls by 10%. That way, they’re out of a position before the losses get too big.
And in general, I agree that the best loss is a small one.
However, this technique worked best when markets were run by humans, the reason being that the markets ran slower.
By that, I mean prices moved up and down at a slower pace.
But today, trading takes place at the speed of light. And I mean that quite literally.
Trading at exchanges happens at an unbelievable pace. A firm trading stocks can execute more than 100,000 trades in a second for a single customer.
Back in 2015, trading between London and New York could take place in 2.6 milliseconds. That’s because of a $300 million transatlantic fiber-optic line between these two financial hubs.
The bottom line is that trading happens faster than ever. It’s only limited by the physical barrier of the speed of light.
Part of a Larger Puzzle
Trailing stops, in comparison, are like the Pony Express. They are an idea that assumes prices stand still for long periods.
Trailing stops assume that intraday prices are real instead of sometimes just being part of a larger puzzle. That puzzle could be someone who is trying to manipulate a stock’s price to get some other asset’s price to move.
In other words, if you think of stock trading as a chess game, it’s a game that’s gotten faster, more complicated and the odds are stacked against you. In fact, algorithmic and artificial intelligence-based traders use retail investors’ trailing stops as a way to accumulate cheap shares.
For example, the website Tradimo.com says:
Stop-loss hunting (also known as “stop runs”) refers to a situation in which some market participants attempt to manipulate, or push, the price of an asset and drive it to a level where other participants have set their stop-losses. When the price reaches these levels, these stop-loss orders are triggered, and market volatility increases.
Since trailing stop-losses are based off the latest market price, most people’s stop-losses are at very predictable levels, such as at 10% or 15% from the last price. But these numbers are incredibly easy to game.
In other words, people using trailing stops are an explicit target of manipulation today. And to me, it’s a way of getting stopped out of stocks that in many cases are just going to be down for a few seconds. Then a few seconds or minutes later, the stocks soar higher.
This is why I don’t use trailing stops in my services. Instead, we use a regular stop-loss.
A regular stop-loss means you sell when the stock goes below a set percent from your original cost based on the closing price of the stock. I believe this is a better system than trailing stops because closing prices are harder to manipulate.
Also, because each person’s cost is different, each person’s stop-loss is different. That means there’s no easy level at which you can be hunted down for your stop-loss price.
Editor, Profits Unlimited