In previous posts we’ve introduced stops, talked about the necessity of using them, and the profit protection they provide. Specifically, in our post of April 8th, “In praise of trailing stops: EZPW“ we talked about how trailing stops can help you protect profits. We are a few weeks down the road now so let’s have a look and see how that decision panned out with the value of hindsight (stop triggered at $32.06 on April 6th for a 12.6% profit in a little over two months):
This is an hourly chart, by the way. We can see that although we had a significant blip at the open yesterday, EZPW closed significantly down from our trigger price. Additionally, the drop of from our trigger point was precipitous, and would have more than erased our profit if we had lost our nerve and sold at the bottom. (A stop set at the buy price of $28.45 would not have triggered, but our point in all this is profit protection, not long-term holding).
Now, to that point not everyone is in favor of trailing stops. I think it is Stephanie Pomboy of MacroMavens who points out that she dislikes them because determining a re-entry point is difficult at best. Indeed, that point of re-entry is an issue, especially if the position being liquidated is one in which we have a long-term interest. I am confronting the issue of where to set stops for positions in which I have both a long term interest and where I also have a substantial accumulated profit. The use of Average True Range (ATR) trailing stops may provide the best answer, although they do require a bit of work. Making money usually requires a bit of work, though, in my experience.
But what is the ATR? Investopedia defines it as follows:
A measure of volatility introduced by Welles Wilder in his book: New Concepts in Technical Trading Systems.
The true range indicator is the greatest of the following:
- -current high less the current low.
- -the absolute value of the current high less the previous close.
- -the absolute value of the current low less the previous close.
By introducing volatility into the calculation of our stop values, we may more appropriately be able to account for daily movements in the stock price to minimize the chance that we will be whipsawed out of a position while still protecting profits we have built up.
In recent weeks, due to some international travel where I might not have been able to pay the best attention to my positions during the trading day, I have set some pretty tight stops on positions in which I had accumulated a better than average profit. All these stops have now triggered, the last of which, in SIVR, triggered yesterday for a 52.5% profit. Other positions that triggered include AGQ, BNO and TSCO, all for very nice profits. My personal policy is that I will never feel bad about realizing a profit and will deal with the issue of where to re-enter the position later. All these stops had been set at between 5-6% and were standard trailing stops, as I was not sure how I might maintain them. But using SIVR as an example, how might we calculate an ATR trailing stop? I will use SIVR as an example.
This view is actually my standard chart view in TC2000, although I’ve added some pointers to highlight my entry and exit points and the average true range, which is shown here at its default setting of fourteen days. This is a daily chart in which you can see that the last ATR14 value is $1.24 at a last price of $44.85. If one were to tend to a short term view then an ATR stop of 2*ATR14 would be appropriate, which in this case would equate to ~5.5%. As a side note, the trailing stop that triggered yesterday was set manually at 5%. If you take a longer term view then 3*ATR14 might be a better choice. In this case that would equate to an 8.3% stop. How top-heavy the market feels to you, how much profit one wishes to protect, and so one might impact how tightly you might chose to set your stops. But you will know that you are taking account of the recent volatility in the price of the instrument you are seeking to protect.
From a personal perspective, I will probably use ATR to set stop values for instruments that I am concerned about protecting. If the holding is one that requires special attention, I might review the stop on a daily basis, but otherwise I think once a week should do it.
In closing, let me note that you are seeing my charts in Worden TC2000. I used to use Metastock for my “serious” charting but have recently changed to TC2000 and find it much easier to use without the expense of a separate monthly data feed subscription. The Worden website has many free tutorials that, while they showcase Worden products, are applicable without them and are of a high quality.