Bulkowski's Abgenix Stop Placement Quiz

Imagine that you bought the stock at the upward breakout from the flag in July. Where would you place a stop?

Answer: Most chart patterns form because the trend stops; price moves sideways as the bulls and bears fight for control. That fight turns into support (when price drops into the area) or resistance (when price rises into the area). Thus, most chart patterns offer support or resistance. Placing a stop below the flag at 1 (blue line) would work. When I test a chart pattern, I assume a stop is a penny below the bottom of the chart pattern.

In this case, point 2 would be a choice for more volatile stocks, but it's farther away so you would incur a larger loss than if you used point 1. Point 2 is just below the horizontal price trend (shown by the horizontal line).

Point 3 is a throwback. I always assume a throwback will happen. That's when price returns to or nears the breakout price within 30 days and shows white space in the process. The white space rule is used to prevent a throwback label from being applied when price slides along the breakout price instead of moving up and then curling back down.

As price rises, raise the stop, but to where? When price at point 5 rises above the prior peak at 4, then raise the stop to 6, the prior valley low. This method doesn't always work. Consider points 7, 8, and 9. Price at 8 (a new high) rises above point 7 (the prior high), so this would call for a stop at 9 (the prior low). The low at point 9 is at 9.88, and price closed at 15.03 at point 8. The stop would be 52% below the close. That's huge.

Try to keep your stops less than 15% away at the start of a trade and below 10% away as the trade progresses.

Point 10 is a closer minor low, another choice for a stop. Point 10 bottoms at 12.16, but that's still 24% away. It's still too far below the current price.

Another method for stop placement is to use a Fibonacci retrace. That's when price drops back between 38% and 62% of the prior rise. Look at points 3, 11, and 12 in the lower left of the price trend. Point 3 bottoms at 5.16, point 11 peaks at 7.19 and the retrace bottoms at point 12, at 6.03. The move from 3 to 11 is 2.03 points. The decline from peak 11 to bottom 12 measures 1.16. Thus, the retrace of 1.16 out of 2.03 points, or 57%. A stop placed at the 62% retrace of the move from 3 to 11 would have worked (I prefer a 62% retrace value as price most often reverses before reaching it).

One last method is to use a volatility stop. Dump the daily price data into a spreadsheet and then calculate the difference between the intraday high and low -- think of it as the daily price range. Place the result in a separate column then average the last month's worth of data, about 21 values, to get the average daily price volatility.

Next, multiply by 2 (testing shows that 2 results in better performance than 1.5) to get a volatility reading.

Let's say the average price range is $1. Multiply it by 2 to get $2. I use the current day's low and subtract $2 from it. A stop should not be any closer than $2 below the current low. If the stock has a low of 40, I would not put a stop closer than 38.

A volatility stop would work well for Abgenix because price has zoomed upward. Also note that the scale is logarithmic not arithmetic. I prefer the log scales as it shows more detail when price makes a large move and trendline piercings will occur sooner, too.

Finally, some brokerages have automated trailing stops. You set the dollar amount or percentage below the price and the stop is raised automatically as price moves intraday.