Daryl Guppy is founder and Director of Guppytraders.com. He is a full-time active private position trader, trading equities and associated derivatives markets. He is an appointed foundation member of the Australian Government Shareholders and Investors Advisory Council.
He is the developer of the Guppy Multiple Moving Average Indicator included in EzyChart. He delivers accredited courses for the Singapore Stock Exchange. He also runs public trading workshops, and equity and futures brokerage sponsored seminars, throughout Australia and Asia.
USING EFFECTIVE ATR STOPS
The Average True Range (ATR) indicator is one type of volatility based stop loss tool. The Count back line (CBL) is also a volatility based stop loss. The example below uses both the ATR and the count back line as a trailing stop loss. The trade was constructed to apply as a short-term trend rally until a longer term trend can be plotted based on retreat and rebound points. It was managed using a 2xATR volatility based stop loss and a count back line. The Guppy Multiple Moving Average (GMMA) was an additional tool used for defining the emerging trend.
The Average True range is a useful tool for managing volatility. However in its usual display (in a separate window on a screen) its usefulness is blunted. Even when displayed over a chart, the ATR is not an easy tool to understand.
We will use the 2xATR tool included in the Guppy Traders Essentials toolbox or EzyChart 6. This will plot the value of the ATR line beneath the rising trend. However, it only plots higher ATR values. This means that when a lower ATR value is created the indicator tool simply extends the most recent highest ATR value to the right. The result is a stopped series of rising stairs beneath the trend.
When there is an intraday move below the current highest value of the ATR, the indicator extends the line to the right edge of the chart and provides an exit signal.
The chart displayed (above) shows both the ATR tool and the Count Back Line tool. The text details and tracks the changing value of these two indicators. Generally the ATR value is higher. This means it would trigger an exit before the Count Back Line. This confirms that the ATR is a more sensitive volatility indicator.
However, in tracking any trend, the balance must be struck between sensitivity and robustness. Too sensitive and the indicator will generate a false exit. The trader gets out of the trade, but the trend continues upwards. We find the CBL a more effective tool for trend definition. The sensitivity of the ATR makes it more suitable for intraday style trades where the objective is to scalp for smaller profits.
When the trade was added at $0.53, the ATR value started at $0.48. This value was higher than the CBL value at $0.44. In this example, the 2xATR is a more sensitive stop loss technique. As the trade develops we will have the opportunity to determine which is the more effective stop loss conditions - the volatility based CBL or the time/volatility based ATR.
When the 2xATR stop lifted $0.53 the CBL value is also at $0.53. This agreement between techniques did not prevail for long. When the 2xATR stop was lifted to $0.55, the CBL value was higher $0.58. This means the CBL is more sensitive to changes in volatility and will signal a more rapid exit.
We find this an advantage as the placement of the CBL is directly related to changes in daily volatility, whereas the 2xATR remains a fixed relationship to time.
First Published: 16 August 2005 - Copyright © Daryl Guppy
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