Thanks again to Jeff L. in Seattle for this explanation of the "Average True Range"
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Is there a Technical Indicator I can use to tell me where I should place my Stop Order?
After you have completed all your analysis to place a trade, now the fun begins. “Where do I place my stop order?” Setting a stop order is mandatory if you are interested in limiting your losses, and you must limit your losses to be a successful trader. In determining where to set a stop order, a few questions to ask yourself are, how much are you willing to lose? Where is support? Where is a safe place I can place a stop that will protect me, yet not take me out on a volatile day? I occasionally hear people say that they wish there was a technical indicator that could be used to take out all the guesswork of where to place a stop. Guess what? There already is an indicator that can be used to facilitate this! The indicator is called an Average True Range, or ATR indicator.
J. Welles Wilder introduced this indicator in 1978. The ATR indicator is used to measure a securities volatility, not price direction or duration. It was originally designed for commodities since it takes daily price data into consideration, but can be used for stocks as well. The ATR is most commonly used at a 14 day time period. To see this indicator, go into the Interactive Chart and select it from the “Select Studies” drop down menu. When you add it to your chart it will give you a current reading relative to your stock. Keep in mind that a $20 stock will have a lower ATR reading than let’s say a $100 stock. The idea is to see what the indicator tells you now, and what your extreme high points and low points are.
Let’s assume your ATR gives you a reading of 2.0, and a high of 3.5. This means that the stock as of now could fluctuate within a $2 price range. Over time if 3.5 is your highest ATR reading, than historically you can see that even at it’s wildest moment, the stock didn’t swing more than $3.50 during heightened points of volatility. So even if I wanted to use an extreme measure, I could set my stop $3.50 below the stock price and this would be a safe enough place to not trigger my order on a volatile day, yet still protect me from a potential breakout to the downside. You will still want to use support and resistance points to tell you if your stock breaks and one of these points, but an ATR indicator is a great way to set a stop order when you are trying to find where even the most volatile points won’t trigger it.
So, how can we use the average true range in calculating our stop loss? All you do is you subtract a multiple of the average true range from the entry price. I might take two times the average true range and subtract it from my entry price. For example, if we had a one dollar stock and its average true range value was five cents, I would simply take a multiple of the average true range, which I said we’ll use two in this example, and we’d subtract it from our entry price. So, two times our average true range is ten cents, subtracted from our entry price gives us a stop loss value of 90 cents.
Now, by adhering to this pre-defined point at which I sell, I know that if the share price doesn’t move in my favored direction, and actually moves against me, I already know the point at which I’m going to sell. My emotions are removed from the equation, and I just simply follow what my stop loss says. This is how most successful traders limit their losses. They know when they’re going to sell and they have this pre-defined before they even begin trading. Although their methods of calculating the average true range and the stop loss may be different the one common element here is that they have a stop loss in place.
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Now, by adhering to this pre-defined point at which I sell, I know that if the share price doesn’t move in my favored direction, and actually moves against me, I already know the point at which I’m going to sell. My emotions are removed from the equation, and I just simply follow what my stop loss says. This is how most successful traders limit their losses. They know when they’re going to sell and they have this pre-defined before they even begin trading. Although their methods of calculating the average true range and the stop loss may be different the one common element here is that they have a stop loss in place.
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See also ......
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