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Stop Losses - Volatility Based
http://www.financial-spread-betting.com/course/stop-order-types.html PLEASE LIKE AND SHARE THIS VIDEO SO WE CAN DO MORE! For this third example of stop losses, we are looking at volatility based stop losses. These are designed to reflect how much the price is moving around, giving it space to move if it is being lively and keeping it contained if it is relatively calm, to minimize any trading losses.
The volatility based stop loss makes a lot of sense if you think of it in those terms. The trick with setting a stop loss level, as we’ve said before, is to make sure it’s tight enough that we don’t lose too much if the trade goes against us, but to make sure it’s wide enough that it doesn’t throw us out of a trade that will turn out to be a winner, if only we had stayed in it.
We have already met one tool which measures volatility, the Average True Range indicator. As a reminder, this takes the maximum absolute amount of the difference in high and low, or the difference between a high or low to the previous close, which is called the true range. These values are averaged, quite commonly for 14 periods though this value can be set, to form the Average True Range or ATR.
To use the ATR to set your stop loss, you need to take a view on how far you want to let the price have freedom to range. Some traders will set their stop loss at 1½ times the ATR away from the entry. Others, particularly short-term traders, may take as much as three times ATR to allow the price more room to move without throwing you out of the trade.
As before, you may choose to simply select the value and watch the chart to see if the price moves against you, so that you can exit at the appropriate time; or if you plan to leave the trade over several days, you may place a stop loss order with your broker.
The ATR is not the only measure of volatility that you can use. You can make it even more simple by checking out the length of the largest candle in the last number of days, and take that fluctuation in price as your baseline when setting your stop loss. Once again, as with the ATR, depending on the type of trading you are doing you can apply a multiplier to that value and then set your stop loss that distance away from your entry.
Using volatility to help you set a stop loss level takes into account the “noise” that you see in every price chart, but it takes it into account by using actual measurements of past movements rather than by guessing how much noise you may see in the future. As always, past performance is no indication of future results, but barring a change in circumstance on the financial security, your expectation is that the price will continue to fluctuate as little or as much as it has in the past, at least for the short time you will be trading it.
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