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Standard Deviation (Volatility) Stop Losses

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SD Stops

A Standard Deviation Based Stop Loss Calculator

This image shows the layout of SD Stops.

The standard deviation is the statistical tool used by statisticians in their measurements of variance.  SD Stops uses the standard deviation to determine statistically valid stop-loss levels. It computes stop losses for both long and short positions. When implemented as trailing stop losses, such stops can help reduce the unnecessary loss of gains after an advance. In the opinion of most statisticians the standard deviation is the best and most statistically valid measurement of variance available (for shares, "variance" would be price excursion).

Let's look at an example that is easy to visualize.  A standard deviation can be used to estimate the full range of heights of 10,000 men in an arena by measuring a random sample of 100 of those men (assuming the 10,000 men in the arena are randomly distributed by height and that the 100 men are selected randomly). The standard deviation can even give a relatively accurate estimate of how many men in the arena are 6'8" even if there are no men of that height among the 100 men measured. Fairly accurate estimates can be made because the frequency of occurrence of various heights in a population follow what is known as a Gaussian distribution or normal bell-shaped curve. The same is true of IQs, the weights of people, muscular strength, and so on. Many market players believe it is also the best way we have of estimating the probable range of price surges of a stock. Price surges are a form of variance and are known by investors as volatility.

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.  For example, a standard deviation can be used to estimate the full range of heights of 10,000 men in an arena by measuring a random sample of 100 of those men (assuming the 10,000 men in the arena are randomly distributed by height and that the 100 men are selected randomly). The standard deviation can even give a relatively accurate estimate of how many men in the arena are 6'8" even if there are no men of that height among the 100 men measured.  Similar procedures may be used in reference to IQs, the weights of people, muscular strength, and so on.  

For example, in any large normally distributed set of trait measurements we know that trait measurements that are ½ standard deviation or more greater than the average (B in the chart) will occur 30.85% of the time. Again, this is a law of nature. Similarly, we know that
1. measurements 1 standard deviation or more greater than the average occur 15.87% of the time.
2. measurements 1.5 standard deviations or more greater than the average occur 6.68% of the time,
3. measurements 2 standard deviations or more greater than the average occur 2.28% of the time,
4. measurements 2.5 standard deviations or more greater than the average (F) occur .62% of the time, and so on.

Our stockdisciplines.com traders 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). You can do the same thing. The word "approximate" is used because stock price variations are not exactly "normally" distributed, but they are close enough for our purposes.  Assume for a moment that stock price spikes precisely followed a "normal" distribution or bell curve. Then a stop that is set at 1.5 standard deviations from the average price would be triggered approximately 6.68% of the time. Assume that during the last 20 days there were no special news events that inordinately influenced the stock and that the same conditions prevailed over the next 100 days.  In that case, spikes large enough to trigger a stop set at 1.5 standard deviations would probably occur about 6.68 times in 100 days or about once every 15 days simply because of the normal volatility or "noise" in the stock’s behavior.  If we use 2 standard deviations, then a spike large enough to trigger the stop would occur about once every 50 days.  For a more complete discussion of Standard Deviation and its application, see  Stop Loss Probabilities     

To compute a volatility-adjusted stop loss, it is necessary to measure price spikes and the approximate frequencies at which price spikes of various magnitudes occur over a given time. Measuring the distances of each day's high and low from the average price over a given period will yield the needed data. This information can be used to approximate the probability of the occurrence of a spike of a specific magnitude (as represented by its distance from the norm in standard deviations).

How does this help? If your holding period is projected to be one week, you don't need a stop loss that has one chance in a thousand of being triggered. Probably, one chance in three weeks (1 in 15) or four weeks (1 in 20) would make sense. On the other hand, if your holding period is 1 year (253 market days), you might require an event that has only 1 chance in 500 of being triggered because of the stock's "noise" or random fluctuations. By placing your stop loss the correct number of standard deviations away from the stock's average price, you can make it highly improbable that your stop will be triggered merely by the random lurches of your stock. In other words, volatility-adjusted stops enable you to set your stop loss just outside the probable "event envelope" of the stock's price behavior. Hence, your stop will not be triggered because of the normal fluctuations in price. It would take a downward price surge that is not "normal" for the stock to trigger your stop loss. 

Features & Description

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, though we do provide an introduction with some procedural suggestions in a cover note to licensees of the program.  The program is designed to monitor up to ten positions.  For example, for the first position , a person could enter an "S" in cell E-6 to calculate stop losses for short positions, or leave cell C-6 blank to calculate stop losses for long positions.  If youy enter "S" and the stock has been in a strong uptrend, all you will see is sell signals all over the place.  That would make little sense.  Instead, use the "S" option when the stock has been declining, just as you would use a regular stop loss when a stock has been rising.  A person can enter a 1, 2, or 3 in cell C-6 to base stop losses on the highest high, low, or close, respectively.  A number from 1 to 3 is usually entered in cell G-6 to make the tool weight the standard deviation measurement by the entered amount when computing stop losses (one standard deviation, two standard deviations, etc).  Decimals can be used in G-6 entries.  For example, 1.25 standard deviations, 2.14 standard deviations, and so on, may be entered.  The data must be entered with the oldest data at the top in row 8 and the latest data at the bottom. The program also has a module that calculates Fibonacci retracement levels.  It is identical to the module in Stops, and it is demonstrated in the video for that program.

Because it is difficult to visualize the probable real-life experience of setting a stop loss at any standard deviation multiple, we have included a LAB in SD Stops where you can see a red stop loss line below a stock's price action, and adjust the line by entering different multiples of the stock's standard deviation. When you see how often, and under what circumstances, a stop loss is triggered, you can adjust your settings to suit your own tolerance for risk. To create the LAB, we looked for stock price action over a five-year period that included a wide variety of behavior patterns, so that it would be useful for just about anybody who invests. The stock tracked in the LAB is fixed. At one time we provided charts for all the stocks being tracked, but the charts tended to be damaged by users too often, rendering the charts non-functional and needing repair. Consequently, we now provide charts that cannot be modified by the user, but they include enough variety that people should be able to get a sense of what conditions would trigger a stop loss.

You must be able to open and use an Excel 2007 spreadsheet with macros on your computer to be able to use SD Stops. To test your system, click on the following link. It will take you to a page where you can download a small .exe file with a macro (SD Stops has a few macros).  Do not try to open the file with Excel.  That will not work.  The file, like SD Stops, is executable.  That is, all you have to do is click on its icon.  If you can enter a number and cause the spreadsheet to recalculate, and if your system can pass the macro test provided, then you should have no trouble using SD Stops on your system.  

Notice: There are compatibility issues with Excel 2003 and earlier versions of Excel.  Do not attempt to take the test or order SD Stops without contacting us first if Excel 2003 (or any earlier version of Excel) is installed on your system.  SD Stops may permanently disable all menus from Excel 2003 or earlier versions of Excel.  This is not an issue with later versions of Excel   Go to the test page. 

The Cost

 The use of SD Stops for a year costs less than the price of a subscription to the average stock market newsletter. The average market letter consists of 8 to 12 pages of opinion. On January 22, 2001, Money reported on a survey it made of 61 market letters. The average annual subscription price for these newsletters was $220.46. We have not checked lately, but we are sure prices have gone up considerably since then.  A simple cost of living adjustment through June of 2017 would increase the price to $308.41.  Another way to look at it is that an adult could buy two regular 1-day tickets to Disneyland for $220.00. The price of using ATR Stops for 6 months is only $149. The money spent for two tickets to Disneyland pays for a few rides and maybe a few moments of pleasure. The money spent on SD Stops is spent to enhance assets.  Better stop loss placements can easily translate into far more in profits and savings than the price of using the program.  Even one well-placed stop loss might save many times the cost for a year of use. The 6-month license renews automatically until canceled, so you don't have to keep re-ordering every six monthss. 

Ordering and The License Agreement

Read the License Agreement for details before ordering.  To read the License Agreement, click on Agreement.   An order cannot be transmitted to us unless you acknowledge that you have read the License Agreement.

Previously, we did not offer a trial period because we could not turn the tool off remotely once we sent it to a user. We believe we have solved that problem. We can now program the tool to automatically shut down if new codes are not entered after a trial period. See the License Agreement (above link) for details about the trial period.    If you are interested, click on summary and opportunity to order.

Click on the following link to learn about another of our stop loss calculators.  Stops 

Other Stop Loss Related Information On This Site

Stop Loss "Psych-Outs" Stop Losses and the 4-week Rule
Stop Losses and Probabilities Stop Losses and Risk Control
Stop Loss Relation to Diversification Stop Loss Long-Term
Stop Losses Getting Triggered Stop Losses and "Normal Fluctuation"
Stop Loss Information Stop Loss Tool

For more information on standard deviation and its meaning and use in stop loss calculations go to http://www.stockdisciplines.com/stop-loss-probabilities

Links To Popular Articles/Lessons
Topics of Interest
Do You Sell or Hold After Your Stock Has Dropped? Strongest Stocks
he Best Stop Loss for Long-Term Investors  Stock Scanner
The Triple Moving Average Crossover System  ATR Stops
Stock Buy and Sell Signals With The CCI Momentum
Buy and Sell Signals of A Moving Average System  Strongest ETFs
A Test To Find The Best Moving Average Sell Strategy  Stock Market Review
Creating a Trader's Diary  Stop Losses
Use Time-Stops on All Stock Positions  Stock Alerts
The Probability of a Stop Loss Being Triggered  Breakouts
Stock Trader Probabilities  Stock Market Lessons
Moving Average Signals   Products & Prices

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