It’s the worst-case scenario…
You researched the trade, made your buy and set a stop loss to limit your risk.
The next morning, the stock you bought is down big in pre-market trading.
It is set to open below your stop loss and hand you an ugly loss – a loss much bigger than you were planning to take.
This is a terrible position to be in as a trader.
You thought your risk was capped at 8% by using a stop loss.
But bad news came out overnight, and the stock gapped down.
It doesn’t happen that often. But it can happen. And it’s not pleasant.
So, you need to be prepared to deal with it.
Here’s how I would handle a situation like this…
The 10-Second Rule
First, I cancel my initial stop loss order before the market opens.
Otherwise, it will be executed the second the market opens.
I watch the stock trade as it opens and give it no more than 10 seconds.
If the price isn’t rising within 10 seconds, I hit the button to “sell at market” and exit the trade immediately.
It’s painful to take a bigger loss than you planned, but if the price fell that much overnight, it could easily keep falling and get even worse.
If the stock does begin to rally in those 10 seconds, I place a new stop loss order at the low of the day.
That way, the worst-case scenario is that I’m getting out where my original stop would have triggered anyway.
But if it keeps rising, I can sell at a higher price and shrink the loss.
The good news is this doesn’t happen very often. When it does, nine times out of 10 it is the result of an earnings release.
Luckily, we know when companies are scheduled to report earnings.
So, if you don’t already have a profit cushion, you can sell before the announcement and avoid the risk of a bad number.
I experienced two overnight gaps recently – one good and one bad.
The Good & The Bad
Monday was a good gap, as you can see in the chart below.
The Tesla, Inc. (TSLA) trade I told you about last week delivered a nice profit when the stock opened higher Monday morning.
The other “gap” wasn’t in the stock market. But I woke up to bad news just the same…
You see, I’m in the middle of renovating our new house.
I just had brand new heart pine floors installed, and the painters started this week.
A carpenter was doing some trim work over the weekend, and Sunday morning I woke up to this…
Apparently, the carpenter overflowed a toilet and flooded the downstairs.
$20,000 of brand new wood floors are warped and ruined!
Cut Losses Quickly
Unlike a stock trade, this loss has no chance of correcting itself. But my mentality is the same – cut the loss and move on.
This carpenter will not be allowed back in the house.
I will not wait weeks for him to patch the damage, drag out the schedule and end up with a mediocre result.
I filed a claim with his insurance first thing Monday morning, and I will hire a flooring professional to redo the job.
As a side note, be sure to get a copy of a contractor’s insurance policy before letting them do work on your house.
Luckily, I did. If not, he could have disappeared and left me footing the bill.
Waking up to bad news is never fun. But remember, it could get even worse.
So, when you wake up to see a big downward move…
Rip off the Band-Aid.
Take the loss.
And move on to the next trade.
Embrace the Surge,