Author Topic: Volatility Adjusted Stop-Loss Calculation  (Read 7671 times)

Travis

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Volatility Adjusted Stop-Loss Calculation
« on: March 18, 2013, 10:23:53 am »
I don't like fixed stops, as some stocks have greater volatility than others. I've been studying volatility based stop loss calculations and am wondering if this is possible to create in the formula editor. So far, this is what I have gleaned from my studies for the creation:

1. It calculates the true range (TR) of the past two trading days using the highest high and the lowest low of the 2-day period.

2. It calculates the average true range (ATR) of TR (in Step 1), using overlapping periods of 20 days.  A month of data (20 days) is considered suitable because that amount of time makes it sensitive enough to change while at the same time giving output that is statistically valid for computing standard deviations of stock behavior (volatility).

3. It calculates the standard deviations (STDV) of the true ranges in Step 1 using the same period as in Step 2.

4. The stop-loss values are then DDEV = ATR + (m x STDEV), where m = any number the user desires.  SD Stops allows for infinite variation in "m," which is our "Mulltiplier" function.   [1, 2.06 to 2.25, and 3.20 to 3.50 are commonly used for m, where the larger values of the pairs correct for skew and allow for greater risk]

5. The standard deviation stop loss is accordingly (High, Low, or Close) - DDEV.  [SD Stops allows for the reference point to be the highest high, low, or close]  For a short position it is (High, Low, or Close) + DDEV

This procedure adjusts for volatility by using the standard deviation statistical measurement.  By applying it as a trailing stop loss, it can help prevent the unnecessary loss of any equity gained.
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