The Stops tool makes it easier to know where to place each higher stop loss as the stock rises, while simultaneously factoring in the volatility of the stock. No math is needed. The tool automatically incorporates a stock’s volatility in its calculations, using your choice of method, and provides the needed stop loss data as determined by the stock’s own behavior. The Stops tool facilitates a disciplined approach to trading and investing. It helps eliminate emotion from the sell-decision.
One problem traders and investors face is how much to let a stock decline before selling. Our tool addresses this issue. The ideal sell strategy will minimize the loss if the stock plummets but still give the stock room for normal fluctuations while it continues to climb. Correct sell order placement is one of the most important disciplines a trader can learn. The problem is that in order to determine the correct placement of a volatility-adjusted stop-loss, it is generally necessary to use some math. The Stops tool makes the calculations automatically. With this tool, stop losses can be computed on the basis of either of two very different approaches to stop loss computations. Each of these approaches has a virtually unlimited range of adjustment possibilities (so you can adjust them to reflect your own tolerance for risk). This is possible because a weighting factor can be applied to the volatility measurement. The weighting factor can be any positive number (to as many decimal places as you like), enabling the user to "fine tune" his stop loss settings. Stops does all the math for you. All you have to do is tell it what you want.
Stop losses based on volatility measurements are much less likely to be triggered by a random fluctuation in price. Most expert traders and investors will use direct measures of a stock's volatility in the placement of stop losses. A very popular method of traders and investors for computing volatility is to compute the ATR (the Average True Range). An alternative for measuring volatility that also has strong support from statisticians is the computation of the standard deviation of price movement. Traders and investors have learned that the standard deviation is an accurate and powerful tool for setting stop losses. Stops provides a means by which you can use either approach without having to perform the calculations. Below, we will discuss each procedure.
General description: The Stop Loss
Whether a person holds stocks for a few days or for many months, he must make trades. One of the rules of good trading, and of good investing in general, is to "limit your losses and let your profits run." This phrase is often heard in investment circles, but it is not often implemented with discipline. It’s another way of saying that, for the best returns, a person should hold onto a stock only as long as it is climbing and sell quickly when it starts to decline. The use of a stop loss order that follows a stock up as it climbs higher and automatically sells when the stock falls is one of the best strategies known for doing precisely that. It is also the easiest to implement. Because Stops makes the computations automatic, you can spend your time on other parts of your strategy or on refining your discipline.
The Stops Solution
Traders do not want to spend time studying program syntax and non-intuitive procedures that do not follow the standard rules of algebra, and we could find no inexpensive, easy-to-use tool we could recommend that will automatically do the math required to compute the kind of sophisticated stop losses we desired. So we developed one. We call it Stops. Stops is based on and makes use of an Excel spreadsheet. It provides two very different ways to compute a stop loss and each of these can be "fine tuned" to reflect the user's tolerance for risk. All you have to do is enter a few letters ("H," "L," or "C") in cell C-1 to indicate that you want your stop loss calculated relative to the high, low, or close. For ATR calculations, you would enter "5," "7," "14," or "20," in cell C-2 to indicate that you want your stop loss calculated on the basis of the last 5 days, 7 days, 14 days or 20 days. You would enter a number (usually between 1.000 and 4.000 in cell C-3 to "weight" the volatility measurement (volatility x 1.58, volatility x 3.25, etc.).
As you can see in the above illustration, the user can enter a stock's symbol in cell D-1, and the desired data will appear in the blue area. Alternatively, he can simply scroll down the list to find the stocks of interest. All stocks on the list will show data generated by the settings entered by the user.
In the Goldenrod colored strips, you will see "Price," "VA," "Price-VA," and "Price + VA." The letters "VA" stand for "Volatility Adjustment." If a stock has been in a downtrend and an investor is wanting to determine when a reversal has taken place, he might want to calculate a buy price by using a multiple of the volatility measurement. Instead of calculating the price for a stop order to sell, he may want to calculate a price for a stop order to buy. Also, there are times when short sellers will want to add the VA rather than subtract it. In these situations, the "Price + VA" column will be useful. Those who use the tool only for calculating stop loss prices for long positions will focus on the "Price - VA" column.The above illustration shows the tool configured for ATR stop losses. These are stops based on Wilder's original formulas for Average True Range. Stops does not modify Wilder's methodologies or use shortcuts. It uses his procedures of calculation as he intended. Note the gray box in cell G-19. If the user enters an "S" in that box, Stops will re-configure itself to generate data based on the standard deviation.
With the "S" in cell C-19, Stops will ignore any entries in cell C-2. All computations for the standard deviation will be based on 20 days of price activity.
Stops will also show you the data used in computing stops. When the user scrolls to the right, he can view the following data.
The user can see the ATR for the 5-day, 7-day, 14-day, and 20-day periods for all the stocks in the Stops database. He can also see the standard deviation of the Wilder True Range and the latest computation of the True Range. Pivot point data does not show in the above image because it was added later (see the pivot point discussion lower on this page).
Many investors rely on "eyeballing" charts to determine a price at which to place a stop loss (this can be quite sloppy and result in more than necessary loss) or on making their computations manually. Any manual calculations have to be very rudimentary because the more sophisticated computations are too time-consuming. Rudimentary stop losses are usually the first to get triggered unnecessarily because of market "noise." These stop losses may also give up far too much money when they are triggered. Even one excessive loss of .65 on a 500 share trade would cost more than the price of using the tool for a full year. Multiply that by the number of positions incorrectly stopped out in a year to get an idea of the potential savings possible with Stops. The beauty of Stops is that it provides the more sophisticated stop loss calculations without you having to know how to write volatility measurement formulas and without you having to learn arcane program syntax. You simply enter instructions and Stops will do the rest based on the simple instructions you give it.
Most successful investors prefer to place their stop loss just below a recent minor low. A minor low suggests that there is support at that level. An alternative approach is to place it under a significant trendline. However, there are times when the trader can find no recent minor lows or trendlines to use as a reference. At such times, a "mathematical stop loss" can be very useful. Stops can make computations that are based on statistical probabilities. That is, measurements of dispersion like the standard deviation enable a person to adjust the probability of the stop loss being triggered. Thus, by applying the appropriate multiplier to the standard deviation portion of the equation, a person can set the stop loss so that it is unlikely to be triggered because of the normal volatility of the stock within 50 days, 100 days, or whatever. See "The Probability of a Stop Loss Being Triggered" at the bottom of this page for more information.
ATR Stop Losses
The True range is defined as the greatest of the following:
The Average True Range (ATR) is the average of the True Range over a given period. It is a measure of volatility first introduced by J. Welles Wilder in his book, New Concepts in Technical Trading Systems. Wilder recommended a 14-day average of the True Range. (Periods ranging from 5 to 21 days have been recommended, depending on the nature of the security traded and the anticipated holding period). According to Wilder, large ATR values tend to occur at market bottoms after a panic sell-off (volatility is high). Small Average True Range values tend to occur when volatility is low. An example would be during times of prolonged sideways movement (as when a market is topping out or undergoing consolidation).
Stocks will sometimes gap up or down. A volatility formula based only on the high-low range would not accurately capture volatility when gaps occur. Wilder's Average True Range can capture this “missing” volatility because his True Range automatically factors in any gaps. The Average True Range measures how much fluctuation or "noise" there is in a trending stock's behavior. If a person wants to place his stop loss outside this envelope of noise, then he will multiply the ATR by a factor greater than 1. For example, he may multiply the ATR by 1.5 and use the result to calculate his stop. This would help prevent getting stopped out prematurely and will also limit his risk in the trade. Some will prefer a stop that is a greater distance outside the noise envelope and multiply the ATR by a number greater than 1.5. Wilder recommended a multiplier of 3 for intermediate-term to long-term investors. The choice of a multiplier is an individual matter that should be based on the individual's investment time horizon and tolerance for risk. Since there is never a guarantee that a declining stock will recover, the more a stock is allowed to decline, the greater the risk assumed by the investor. This risk must be balanced by the desire to avoid selling to quickly and without sufficient reason. These decisions cannot be made for you. However, lower on this page, we have provided some charts showing where the stop loss would be for various settings.
Wilder's Average True Range was not computed by simply adding up the True Ranges for 14 days and then dividing by 14. He has a unique method of averaging. Stops uses the same unique methodology recommended by Wilder. Though many who attempt to use Wilder's system get poor results because they do not perform the calculations correctly, Wilder's methodology remains a favorite among investors and traders who know how to perform the calculations correctly, because of its effectiveness and relative simplicity.
Standard Deviation Stop Losses
The standard deviation is the statistical tool used by statisticians in their measurements of variance. They consider it to be superior to any procedure based on averaging. Stops enables the user to choose the standard deviation to determine statistically valid stop-loss levels. In the opinion of most statisticians the standard deviation is the best and most statistically valid measurement of variance available (for shares, "variance" relates to the magnitude of price excursion).
It is a fact of nature, like Pi (π) is the same regardless of the size of a circle, that whenever we measure a randomly selected group for some trait which each member of the group possesses in varying degree, we may expect most of the measurements to bunch around the average, while the remainder taper off gradually toward both extremes of the distribution forming a bell-shaped curve. That is, the more extreme the measurements (extremely small or extremely large) the less frequently they occur. If you plot a bell-shaped curve, most measurements will be grouped near the center. The more people there are that are "normal," the larger the group at the center. There are many more men who are 6' tall than who are 7'2" or 3'5." By using the standard deviation as a measure of variance, we can know the probability of finding trait measurements of any magnitude.We can use this information to approximate the probability of the occurrence of a price spike of a specific magnitude (as represented by its distance from the norm in standard deviations). The word "approximate" is used because stock price variations are not exactly "normally" distributed, but they are close enough for our purposes.
Because Wilder's True range effectively compensates for gaps over the shortest period possible, Stops Uses Wilder's True Range as its basic analysis unit rather than the range over one or two days. Some use two days and add a day when gaps occur, but in our view this is a coarser approach, lacking the definition of using Wilder's True Range. Stops calculates the standard deviation of the True Range over a 20-day period and adds it to the Average True Range. The Formula is ATR + (f x StDev) where f is the multiplier or weighting that is applied to the standard deviation. The result is then added to or subtracted from the high, low, or close.
This tool is probably the easiest tool available anywhere for calculating stop losses based on the standard deviation. It is so simple to use that a User's Guide is not necessary. All explanations needed are included on this page.
Because it is difficult to visualize the probable real-life experience of setting a stop loss at any multiple of a volatility measurement, we have some charts below where you can see a red stop loss line below a stock's price action. The charts show how various multipliers determine stop loss placement.
Stop Loss Placement
To give you an indication of the effect of different multipliers on stop loss placement, we have found a stock with numerous reversals to illustrate the point. Below are five charts showing a stop loss relative to the closing price each day (red line). They show stop losses calculated by multiplying the ATR by 1, 2, 3, 4, and 5, respectively. The charts may help you decide on a starting multiplier. You could start with one of the multipliers illustrated, then add to or subtract from the multiplier to meet your needs. Whether you want to use standard deviation stops or ATR based stops, we think you will find these charts useful until you zero in on the settings most suitable for your purposes.
In the following illustrations, the red line rises and falls with the stock. In actual practice, stop losses should only be raised as the stock rises. They should never be lowered. It is always at the highest level reached since purchase. When the stock declines, the stop loss does not. However, if we did that with the illustrations, the red line would go flat or disappear the first time the stop is triggered. This way, you can imagine buying at any point on the charts.
1 x ATR
2 x ATR
3 x ATR
4 x ATR
Fibonacci ratios appear throughout nature. They also appear in market behavior patterns. Elliot Wave Theory makes use of them in stock market trend analysis. Elliot wave analysis plots a graph of the up and down trends of the stock market. It shows five upward waves and three downward waves forming a complete cycle of eight waves. All of these numbers are Fibonacci numbers. These relationships can be applied to both short-term and long-term trends. Many technicians use the Fibonacci relationships in stock behavior patterns to find areas of support and resistance. For example, when a stock makes a significant upward move there is usually a subsequent minor decline as traders take their profits. Market observers have discovered that the relationship between the stock’s rise and the downturn that follows is frequently a Fibonacci relationship. It is not necessary to know how Fibonacci numbers are defined or the mathematical relationship between two Fibonacci numbers in a sequence. It is sufficient to know that the most significant Fibonacci retracements (expressed as percentages) are 23.6%, 38.2%, 50%, and 61.8%.
Stops makes it easy for you to determine Fibonacci levels. It should be mentioned that the ATR and standard deviation stop losses are far more reliable than Fibonacci stops. However, Fibonacci levels can be useful for traders focusing on very short-term price movements. They can also be useful for determining entry points. For example, a trader might decide to take a position if it becomes evident that a stock is getting support in the proximity of a Fibonacci retracement level. To make Fibonacci retracement calculations, enter the high and low prices of the stock’s most recent move in the boxes provided. Various Fibonacci levels will be displayed. Calculations are displayed to 4 decimal places. Stops should be below support rather than exactly at or above it for a security in an uptrend. Most traders will place their stops at some distance below the calculated levels. The amount of “cushion” a trader uses will generally depend on tolerance for risk, time horizon, and the particular trading discipline used. For a security in a downtrend (one you have sold short), you would reverse your procedure. That is, the stop should be above the Fibonacci resistance level if you have shorted a stock in a downtrend. In a downtrend, the lowest price reached in the current downtrend should be placed in the “High” box (as illustrated above) and the highest price reached before the downtrend started should be placed in the “Low” box.
The pivot point is a recent addition to the data provided in Stops. A pivot point is a price level that is used by traders as a predictive indicator of market movement. A pivot point and the associated support and resistance levels are often turning points for the direction of price movement in a market. Prices tend to swing between two levels. For example, if a price is right at the first level of support ("Support 1"), the probability is that it will move back toward the "pivot point" These levels are very weak, and have most relevance for intraday action (day-traders). In an up-trending market, the resistance levels may represent a ceiling level in price above which the uptrend is no longer sustainable and a reversal may occur. In a declining market, the support levels may represent a low price level of stability or a resistance to further decline. Pivot points were originally used by floor traders in setting key levels. Before the market opened, floor traders would calculate the pivot points for the day. With these pivot points as the base, additional calculations were used to set support 1, support 2, resistance 1 and resistance 2. These levels could then be used as trading aids throughout the day. The resistance levels are where sellers are likely to enter the market, depressing prices. Therefore, it is significant if a stock can push its way through the selling pressure. It takes buying demand to push shares higher through levels at which sellers are waiting. Likewise, the support levels are where buyers are likely to enter the market, exerting upside pressure on prices. Therefore, it is significant if a stock declines through the buying pressure. It takes significant share selling for shares to continue dropping, even through levels at which buyers are waiting.
Where S1 and S2 are the first and second levels of suppot, and R1 and R2 are the first and second levels of resistance. The pivot point is located just to the left of "Ticker Symbol" column. However, it is not necessary to scroll to the right and look up the pivot data for each stock. When a symbol is entered in cell D-1, the pivot point data for that stock is automatically shown in Cells G-41 to G-51 as follows.
If an incorrect symbol or if no symbol is entered in Cell D-1, then there will be no data in the Pivot Data module of Stops. Where the blue numbers are located in the above image, there will be blank spaces.
There are approximately 3,100 stocks on the NASDAQ and about 3,029 stocks on the NYSE, adding to a total of about 6,129 stocks. However, we start with a Reuters database of over 8000 stocks. We screen out all preferred issues because of the difficulty of finding charting sites where they can be charted (they have unusual symbols that most charting software does not recognize). Also, if a company has preferred shares, it is extremely likely that it will also have common shares for which it is easy to obtain a chart. We then screen out all stocks that did not trade on the most recent trading day. Stocks that did not trade on the most recent trading day may be having troubles with regulators or exchanges. They also may have stopped trading altogether but remain in the database because Reuters has not yet removed them. In any case, we prefer to avoid stocks having difficulty staying listed or that cannot maintain daily activity/liquidity. We review and update our database (using the above procedure) daily. When our database is updated, stocks previously screened out are included again if the problem that caused their omission has been corrected. This means that virtually any stock in which you have an interest is included in the Stops database. Any stock that is actively traded on the New York Stock Exchange, NASDAQ, or any other U.S. exchange is almost certainly included.
A Change In Our Calculator
Our previous stop loss calculator required that the individual enter data every day for each position. This data consisted of the date, open, high, low, and close. Entering that data or downloading it is time-consuming. The new Stops already has that data, and it is updated daily. All the user has to do is go to the "Subscriber Section" and download the updated Stops spreadsheet. It takes less time to download the spreadsheet than it would take to download the data into most calculators. That's all there is to it.
Stops will calculate volatility-based stop losses in reference to the stock's high, low, or close. To "tell" stops which approach you want to use, simply enter "H," L," or "C" in cell C-1.
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