Background
Volatility is the average of the high-low price range of each day over the prior month (21 entries) multiplied by 2.
I multiplied volatility by 2 to keep it consistent with how I use it for stops, but it is otherwise unnecessary.
Patternz will do the calculation for you. On the Chart form, right click on any price bar then click the Stops
button. 2x volatility will be displayed under Long trades.
Methodology
I measured the 2x volatility of each stock on the buy date and logged how the trade performed. I used data from
1/1/1997 to 6/22/2007. This range included both bull and bear markets. I created three results: the entire 10.5-year
period, 5, and 5.5-year periods with nearly equal number of trades (over 100 for both 5 and 5.5-year periods). The
first period from 1/1/1997 to 1/1/2002 incorporated most of the bear market of 3/24/2000 to 10/10/2002, as posted by
the S and P 500 index.
Results
10.5-years from January 1997 to June 2007
Using the median 2x volatility of $1.13 showed that high volatility trades made 5.25 times as much money as low
volatility ones.
In sample: 5 years from January 1997 to January 2002
The median 2x volatility was $1.29 and high volatility trades beat low volatility trades by 2.69 to 1.
Out of sample: 5.5 years from January 2002 to June 2007
The median 2x volatility was $1.04 and high volatility trades beat low volatility ones by 2.58 to 1.
The in sample and out of sample results were similar. Trades using high volatility stocks resulted in performance
that was about 2.5 times more profitable than low volatility ones, despite the in sample results incorporating most of
a bear market.
Next, I did a frequency distribution of volatility versus performance and found that volatility too high also hurt
performance. The chart shows the sum of profits or losses from trades with low and high volatility readings over the
10-year period. The thinking is that there is a range of 2x volatility that improves the performance of both low and
high volatility trades. The area between the red lines is where 2x volatility results in good profit per trade.
Performance deteriorates outside of the red lines.
The results described here are for stocks only. Check the results of your trades and see what range works best for
you.
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