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Written and copyright © 2009 by Thomas N. Bulkowski. All rights reserved.
Many of you will know to place a stop below a support zone, such as a minor low or region of tight horizontal price movement, but what do you
do with the situation pictured in the chart (point B)? Where do you place the stop?
If you noticed the broadening top with a partial decline at A (which happens to rest
on a 38% Fibonacci retrace of the move up from the January low) and bought in, stop placement was easy. You just placed it a few pennies below A.
Now that price has climbed to B,
placing the stop below a support zone would be foolhardy. The nearest support zone is a small knot of congestion circled in green (if you look closely,
you can see a closer one, just above the volatility stop line, but ignore it).
You can use a Fibonacci retracement of the AB move. To do that, take 38% (or 50% or 62% or whatever your favorite number is) of the difference
between the two end points and subtract it from the
top point: Stop Price = B - (38% x (B - A)). To plug in numbers, we have: 143.67 - (38% x (143.67 - 103.5) or 128.41. I show the approximate level on the chart as a
blue line. That stop location (128.41) is well below (nearly 11%) the 143.67 close, so it is not the ideal case.
Another, and perhaps better, method is to use a volatility stop. My free Patternz program will calculate it for you. Refer to my volatility
page for the calculation (it amounts to taking the average of a month’s worth of high-low ranges, similar to an average true range). The idea behind the stop is
to place it far enough away so you do not get stopped out on normal price volatility. I show the volatility stop as a red line.
When I place a stop, I always check the volatility stop setting
before deciding where the stop should go. In a case where a straight-line run is occurring, such as in APA, a volatility stop can keep you in the trade longer than using other methods.
Chandelier Stop
Similar to a volatility stop is a chandelier stop. Compute the average true range over the past month, multiply it by 3 and subtract it from the current high price. The result
is the stop value. My volatility stop uses the high-low average instead of the ATR with a 2x multiplier but subtracts the result from the daily low.
-- Thomas Bulkowski
Written and copyright © 2009 by Thomas N. Bulkowski. All rights reserved. Statisticians do it with 95% confidence.
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