There is always a chance that the stock will reverse direction just after it has triggered the stop loss, no matter where a stop loss is placed. We wanted to know if the amount of decline allowed by the stop loss affected the probability of a reversal immediately after the stock is sold. To answer this question, we computed the percentage of incidents (over a period of about 20 years) in which a drop of various specified magnitudes from a recent high was followed quickly by a resumed up-trend, rendering the sale unnecessary.

We discovered that by changing an automatic stop-loss from 8% (below the high) to 9%, we could cut the percentage of unnecessary sales at a loss in half. Further research revealed that after a drop of slightly over 14%, there was another dramatic drop in the number of "whipsaws." A drop of this size was significantly less likely to be recovered by the stock in the near future than for all drops of less magnitude. Therefore, a stop-loss of 15% does make a lot of sense. Sometimes, however, stocks do recover. There is absolutely no way for a person who uses stop-losses to avoid selling some stocks just before they resume an up-trend. Regardless of where the stop-loss is set, this will sometimes happen. It can only "know" what iS (the information that is available at the time of the sale).

When we decide to keep a declining stock, it is because evidence suggests it is the best thing to do under the circumstances at that moment, not a week later or even 5 minutes later. By definition, hindsight never exists in the present. Therefore, we will sometimes be wrong. If we keep the position and we are wrong, our loss might be 15% on that one position. However, we will probably be right more often than if all stocks are automatically sold under a stop-loss discipline that automatically sells on any decline of less than 15%. That does not mean a stock should always be given latitude to drop 15% before it is sold. The patterns of support and resistance (demand and supply) displayed on a chart of the stock are mitigating conditions. We have found that setting the stop-loss at about 15% for long-term investments generally works well as the maximum decline allowed, but many stocks should be sold long before that. For example, if there is obvious strong support 2% below the current price there is no need to set the stop loss at 15%. On the other hand, an investor could make it a rule that no stock is to be purchased if it is reasonable to set the stop loss any more than 15% below the purchase price.

We analyze support and resistance zones for each stock. When StockDisciplines.com traders buy, they buy with reference to a pre-determined stop-loss that is based on their analysis of supply (resistance) and demand (support) zones. They calculate the stop-loss before they buy, and they buy a stock only if a decline to the calculated stop-loss is tolerable in view of the gain expected. The market does not remember or care where anyone buys a stock. However, it does "remember" past regions of support and resistance. Technicians can see the shapes of these regions in the chart of a stock. Remember that a chart is simply a record of the effect of supply and demand forces on stock behavior. Price and volume movements do tell a story.