Monday, February 05, 2007

"Average True Range" (ATR)

Well Traders, I received a nice email from one of my followers that I thought I would share with you. When I created this blog, along with my other one, http://iron-condor.blogspot.com, it was to promote the exchang of ideas. I know well enouigh that I haven't cornered the market on great trading ideas, which is why I love when others offer their own insight. This email came from Jeff L. of Seattle (probably while drinking a double skinny decafe mochachino latte :P ):

Dear Andrew:

Greetings from the Great Northwest, just south of Seattle. I am also an Investools student. I enjoy reading your blog. A couple things I wanted to mention.
First, I totally understand and agree with having a risk management plan. However, your "rule" about 1% below support as a stop loss can be too restrictive. I am sure you are aware of the concept of Average True Range (ATR), and if not, I am sure you will check on it and add it to your tools. A stock must have room to breath within the confines of a trading system's rule, i.e. move within its ATR. I would suggest you look into amending your Excel spreadsheet to allow your stop loss below support to be the greater value of 1% below support OR 105% of the value of a 20 or 30 day moving average of the stock's ATR.

Jeff, thanks for your email and input. Actually, I had never heard of the ATR though I am cognizant of the pitfalls of tight stop-loss placement. I do see this study available on the INVESTools software along with the ability to change the time frame. I am thinking that the number it returns would be a "safe" place to put your stop-loss based on the number? If it returns "1.5" I guess that would signify $1.50 below whatever the Moving Average (20 Day, 30 Day) you used for the study. Maybe yes, maybe no?

I actually place my Stop-Loss at 1% below support on a quick "Swing" trade. That doesn't necessarily mean below my entry, but at support. If I am looking for just the bounce up to the top of the channel, any break below that support would alert me quickly I made the wrong call and to get out.

On longer term "Trend" trades, I set my stop-loss at 3% below support to give a little more "wiggle room" for a longer time frame. I also have a smaller position at risk because my stop-loss will be larger on a Trend trade than a Swing trade. I actually have another "Stop-Loss" monitor that effectively gives me a "trailing stop-loss" based on the stock prices over a number of days. This is usually a lot more conservative and gives greater breathing room to my trades. Since I have several reasons to get out of a trade (profit target, loss, time, trend break, etc.) I try to give myself plenty of signals which forewarn me of danger or status quo.

Every one has their own rules depending on what trading style fits their profile. I wanted to present another idea for others to consider as part of their trading regimine.

Happy Trading!

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