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Imagine you have purchased a stock at precisely the wrong moment. The instant you have purchased shares, it begins to drop. It seems like there can be strategies for exiting the position without taking losses if you act in a timely manor. What are the names of the strategies traders use and how do they work?

osoclever
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    It is called a stop loss order, but I probably would buy puts. – CQM Nov 10 '14 at 15:51
  • Stop losses will reduces losses if perhaps the market takes a swing faster than you can react. Essentially, it is a market order and absolutely anything can happen. It doesn't reduce loss, except to get out at any cost. – osoclever Nov 10 '14 at 15:59
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    conceptually.... in reality the market for shares is much more liquid due to the market makers being mandated to keep the spreads tight... unless you are in penny stocks, as I might imagine. You can try a stop limit order, but the issue is that your limit might get skipped! :) – CQM Nov 10 '14 at 16:04
  • Related: http://money.stackexchange.com/questions/29798/i-carelessly-invested-in-a-stock-on-a-spike-near-the-peak-price-how-can-i-salva/29803#29803 – BrenBarn Nov 10 '14 at 19:24
  • The question is related but I am not really getting the answers I thought I would. I was hoping to get names of strategies used. One example is like here: http://www.investopedia.com/articles/trading/09/pyramid-trading.asp – osoclever Nov 10 '14 at 20:04
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    Technical trading schemes like the pyramid trading generally don't work for very long (if they ever really did). If they did work, than a few hedge funds/banks would program a computer to run the scheme and soon the cost of the scheme would rise to the point there is no profit. – rhaskett Nov 10 '14 at 23:32
  • @rhaskett - pyramiding is simply adding to your original position when it is and keeps strongly trending. Each pyramid position is usually half the previous position and is only taken when all previous positions are already in profit. As the link above says - if done properly can be very profitable. It is in no way a scheme! – Victor Nov 11 '14 at 11:16
  • @osoclever - before you ever enter a trade you should have a plan for that trade. You should have your reason for entering the trade, the price to enter the trade, and the price to exit the trade. You may have a profit target but most important is to have a stop loss in place in case the trade goes against you. Always protect your capital and don't be afraid to take a small loss on a position to protect a large loss. And never ever dollar cost average down into an individual stock - because you don't know when the stock will stop falling unless it reaches 0. – Victor Nov 11 '14 at 11:24
  • The problem with pyramid is the same in the market as it is in a casino: you may send good money chasing bad, unless you have VERY deep pockets and can afford to continue dumping money in until the trend reverses. In theory it works; in practice most folks hit the floor fairly quickly. And it does assume the trend will reverse, which is not always the case in the market since the company itself has a floor. – keshlam Nov 11 '14 at 16:47
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    I have created simulations using C# that show this can work, both averaging and pyramiding. Beginning with a balance of $3000, a dip of around -0.25% ends up costing $10000 - $35000 to average out. Large amounts of cash can lower your portfolio averages to current levels but only so many people can afford to invest this way. We all know that bottoms cannot be predicted but current prices can be nearly matched for a price, and surely it is a fairly good assumption you can sell near current levels. I can share the math on it, but it is not efficient. I suspect somebody knows a better method. – osoclever Nov 11 '14 at 19:03
  • I should add, I am a programmer and I have been working on ideas like this for a few years. I am finding that other talented programmers do not share their secrets so easily and I was hoping I may get some answers here. – osoclever Nov 11 '14 at 19:13
  • @keshlam - you clearly have no understanding about using pyramiding to add to a position. What you have described as "pyramid" is actually Dollar Cost Averaging - which I agree with - you need very deep pockets to send good money after bad hoping for the trend to reverse to average down your buy price. Pyramiding is the opposite - you only add to your position when you are already in profit - you are sending good money after good money - you are going with the trend and not against it and only get out when the trend reverses. Please learn about a concept before commenting negatively on it. – Victor Nov 11 '14 at 21:06
  • In that case I don't see how it applies to the querant's question, which is about what to do when a stock is dropping. And what you've described is not what I know as dollar cost averaging either... so I agree that there's a terminology problem but I can't be sure how much of it is because the terms are not reliably defined. – keshlam Nov 11 '14 at 22:15
  • @keshlam - Pyramiding was brought up because the OP included a link to it in a comment above. DCA is investing a standard amount at regular intervals so that the buy prices get averaged over time between when prices are high and are low. When a stock or the market is heading south and you are DCA it is exactly what I described. This is especially very dangerous with individual stocks - as you will be playing a losing game never knowing when the stock will recover, if it ever does. You should never buy in a free falling market. Look up Pyramiding in Investopedia to get your proper definition. – Victor Nov 12 '14 at 04:51
  • @osoclever Be very careful. Pyramiding does work in strongly trending markets. DCA will tend to work in mean-reverting markets. However, there is a lot of evidence that for reasonable time scales (neither seconds nor multiple years) markets are neither generally trending nor generally mean reverting. You are correct that it can work, but if either of the above simple ideas did work consistently they are so easy that hedge funds would have thrown so much money at them that they would no longer work. – rhaskett Nov 12 '14 at 08:37
  • Consider a chart from yesterday(11/11/2014). VOD - rose with high volume. Shortly after the open, the stock fell roughly one-ish percent. Afterwards, it recovered just fine. It was indicating it would drop in premarkets. After testing last night I found that several attempts at averaging out (on -0.25% dip) cost even more thank 50k. Again, in this case, averaging and pyramiding work, but cost a lot of money. After looking through tick data, I see that other traders have odd amounts such as 513($17,698) shares in their trades. I assume they are employing a similar method. – osoclever Nov 12 '14 at 12:56
  • @osoclever - if you are looking to breakeven on a loosing trade by DCA or pyramiding you are wasting your time and money (particularly with pyramiding as this would only be done if your trade is already in profit). Your best bet if you think you were wrong on the trade is to take a small loss before it turns into a big loss. – Victor Nov 12 '14 at 15:02

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If the stock is below its purchase price, there is no way to exit the position immediately without taking losses. Since presumably you had Good Reasons for buying that stock that haven't changed overnight, what you should probably do is just hold it and wait for the stock to come back up. Otherwise you're putting yourself into an ongoing pattern of "buy high, sell low", which is precisely what you don't want to do.

If you actually agree with the market that you made a mistake and believe that the stock will not recover any part of the loss quickly (and indeed will continue going down), you could sell immediately and take your losses rather than waiting and possibly taking more losses. Of course if the stock DOES recover you've made the wrong bet.

There are conditions under which the pros will use futures to buffer a swing. But that's essentially a side bet, and what it saves you has to be balanced against what it costs you and how certain you are that you NOW can predict the stock's motion.

This whole thing is one of many reasons individuals are encouraged to work with index funds, and to buy-and-hold, rather than playing with individual stocks. It is essentially impossible to reliably "time the market", so all you can do is research a stock to death before making a bet on it. Much easier, and safer, to have your money riding on the market as a whole so the behavior of any one stock doesn't throw you into a panic.

If you can't deal with the fact that stocks go down as well as up, you probably shouldn't be in the market.

keshlam
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  • This is a fact, of course you are right. However, one strategy I have considered is to increase a quantity of the position so that losses have averaged out. This could lead to a very high portfolio balance, but, it could minimize damage and even a small increase could improve probability of profiting. I believe this strategy is called a 'straddle' but it has disadvantages. – osoclever Nov 10 '14 at 15:54
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    Well, if you believe in the stock, you certainly can see a price drop as a buying opportunity. But that's just "hold and wait for the stock to recover" with a new investment alongside it. Whether this is the RIGHT additional investment to make, or if you should put your money somewhere else, requires looking at your whole portfolio and the whole market. It isn't a "strategy", it's just business as usual for investment. – keshlam Nov 10 '14 at 15:58
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    (That's the thing many of the technical "methods" miss. They may -- or may not -- make sense if you're locked into a single stock. They tend to fail badly when you realize that there's a whole market-full of alternatives out there, and that the money invested reinforcing a position in one stock is money not invested elsewhere. I'm a firm believer in "pick your investment mix, maintain your investment mix, but don't get too attached to any single investment." Be willing to accept losses when that's the right thing to do. If you can't, stay with lifecycle funds and/or out of the market.) – keshlam Nov 11 '14 at 23:40