Some Considerations for Setting Stops in High Volatility Markets -- By: Bill Kraft
Copyright 2008, CutLoss, Inc., All Rights Reserved
Bill Kraft
Editor |
"I don't make jokes. I just watch the government and report the facts."
Will Rogers
It is certainly no secret that the recent past has demonstrated a
period of historically high volatility in the markets. One of my very
successful coaching students from this past year wrote last weekend and
suggested that I write an article dealing with setting stops in this
high volatility environment. I agree that subject is something that
might be helpful so what follows are some of my thoughts on the subject.
First I should say that a consistent mantra for me has been to have
an exit strategy in place before ever entering a position. In that
fashion, the exit decision is made out of the heat of battle when the
trader can calmly decide on a disciplined approach to his exit. At the
time of entry I believe the initial exit should be close to the entry
and it should be clear. I personally define the clarity as some line on
a chart. It could be defined by a trend line, a price support, a moving
average, a MACD crossover, or any number of things that remove my
emotion from the exit decision. If an exit is set in that fashion and
adhered to, losses are essentially cut automatically. If I am wrong on
direction I am out of the position with relatively little pain in most
instances. That takes care of the clear part of the initial exit
strategy. If I am right on direction, I may then follow the move by
trailing stops or continuing to use the trend line as the exit (or one
of a vast variety of other methods) in order to attempt to let my
profits run.
The second part of my exit theory is that the initial exit should
be close to the entry and that can be one of the most difficult things
in trading. What is close for me may not be for you. You may be
willing to risk a couple of dollars a share on a position and consider
that amount to be "close" to your entry while I may define "close" as
only 50 cents from my entry. This part of setting stops is one of the
most subjective and difficult parts of successful trading in my book.
One of the problems is that we don't want to be whipsawed out of a
position. As an example, if we set our stop too close on a bullish play
(like buying a stock), the price could dip, we would be stopped out of
the position, and the stock could then turn back up and head north just
as we supposed it might when we entered the play.
Setting stops, in my estimation, is probably more art than science
and it is one of the reasons I advocate practice trading. Paper trade
stop setting to see what works for you. In these volatile days, stocks
have tended to move in a wider range both on a daily and on a weekly
basis -- that's simply evidence of the volatility. The first thing I
conclude from that wider range is that I need to change my definition of
what is "close" during volatile times if I want to avoid being whipsawed
out. How can this be done? Once again, it is subjective. A starting
point may be to check out the daily range within which a stock trades.
Placing a stop within that range may well result in getting taken out of
the position just through the normal daily movement of the price.
Recognizing that probability, we might want to be sure our stop is
outside that range in an effort to avoid an exit occasioned by movements
within the expected daily range. We might also consider looking at a
weekly range to decide whether we want our stop within or just outside
that range. The point is that we know the range for a day or a week is
going to be wider when things are more volatile than they would be when
volatility is reduced. That awareness can help us reach our own
conclusions as to precisely where we might place a stop. In a less
volatile market, stops may be closer and in a more volatile market they
will be farther away if we expect to avoid the whipsaw.
I know of no hard and fast rule to set stops depending upon changes
in volatility; I only know that as volatility increases we need to
change our own approach. We simply can't expect to set the same stops
in a volatile market as we would in a calm market and get the same
results. This area is one in which I often spend a great deal of time
with coaching students and which I have dealt directly in past
seminars. It is one of the hardest yet most important subjects in
attempting to arrive at high levels of success in trading. It is worth
working with someone knowledgeable and practicing on your own because it
can truly inflate your returns.
Good Trading!
Bill Kraft
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IntercontinentalExchange, Inc. (ICE)
ICE has been dealing with a support/resistance level in the
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Trend trading as we try to practice it is a form of momentum trading. We prefer to try to capture profit out of the middle of the trend rather than try to catch reversal at bottoms and tops.
Here's a look at a trade Bill is currently working on:
Pennsylvania Real Estate Investment Trust (PEI)
Trend Trader closed a trade on PEI last Monday for a 4.8%
return before a small commission in a two week play. The timing was good
as the stock dropped back to support right after my exit. I like the
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up after it finishes dealing with the current support level.
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Bill Kraft
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We really enjoy trading stocks that are $10 and under. Often they provide the chance to enjoy high percentage gains and, of course, at worst, the risk is limited to what we paid for the stock.
Here's a look at a trade Bill is currently working on:
NVIDIA Corporation (NVDA)
NVDA is set up in a very interesting way. There is a
support level around $6, a support/resistance around $9 and another
resistance at $12. A bounce up off the $6 level might offer an entry
with the first target the $9 support/resistance while a move up from the
$9 area offers a next possible target around $12. In either event, if I
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support level if it turned out that I was wrong on the direction.
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Bill Kraft
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