Volatility And Stop Placement

Last week, we talked about the importance of trading markets that move in fairly large ranges. Today we will look at adjusting your stops to reflect added volatility.

There are two schools of thought on stop placement. Both Kevin Haggerty and Mark Boucher have told me that they usually risk a fixed amount in any given position, and volatility is secondary to where their stops are. Kevin, for example, risks 1/4 - 3/8 of a point in a stock. Mark usually only risks 1/2% - 1% of total account value on a position. Both use these tight stops with a philosophy that the position should immediately move in their favor, and if it doesn't, they are wrong and should get out. Both gentlemen have had solid success with this approach.

The other school of thought (and the one I subscribe to) is that stop placement should be adjusted to current volatility. The protective stop on a stock with a five-point range should be different than a protective stop in a stock with a one-point range. This approach will get you stopped out less than the previous approach (more breathing room) but will also give you bigger losses on a per-trade basis.

Which approach is better? It's a personal choice that only you can answer based on your trading style and risk tolerance. If you don't mind taking healthy losses from time to time, the second approach works. If you want to minimize losses on a per-trade basis, the first approach is better.

Again, this is a personal choice only you can make. The most important feature, though, is not which one you choose, but the fact that you are using stops. This is usually the difference between long-term successful traders and traders who are correct 19 out of every 20 trades and still lose money because of that one very bad trade.