May 23, 2014

Logic of a 10% stoploss

Every now and then I write buy so-and-so with min 10% SL.

What is so great about this 10%? Why not 5% or 20%?

One word about stoplosses... keep it too tight and you will out of trades every now and then. Keep it too deep and you will up giving up a lot of profits.

My quest was for something in between... a reasonable stoploss which keeps you in trade without kicking you out too often.

Now every stock has something called a trading range. Stocks tend to move up or down within a certain limit. This range itself can change over time but generally it falls within a certain range.

This range or Average True Range (ATR) is the higher of high minus low or change in overnight close (absolute value). This is calculated for a certain number of days and the standard is 14 days.

What I have seen is that the ATR for most stocks is under 5%. So I take double of this and say the maximum range should not exceed 10%.

This means if I keep SL above 10%, it has a very slim chance of getting triggered and if it does, I must exit the stock.

Some exceptions and issues:

Every rule has an exception and it is no different here. The exceptions arise because of the nature of the market.

Sometimes,  a stock tends to trade in a small range for a very long time. So the ATR drops down substantially but if you still keep an SL of 10%, you can lose a huge amount of profits.

Alternatively, a stock can become very volatile and show large swings. This can jack up the ATR with the result that  a 10% will easily push out of a trade.

Lastly, rangebound markets become a problem. This is true of every indicator in markets so you should set SL visually.

Extension of this logic to other timeframes:

You can use this logic/ approach for any time frame with the caveat that smaller timeframes lead to a higher number of trades.

So if you are using hourly charts, you may need to keep an SL of 2-3% and less if you are using 15 minute charts. Now this is just  a figure I put and you should take double the ATR for that stock.

No comments:

Post a Comment