Placing a stop-loss requires delicate balance. We want adjusted beta formula investopedia forex stop-loss to be as tight as possible, while giving the trade enough room to whipsaw. The key to this balancing act is volatility.
You need the stop-loss to be tight to control your risk. But it must be wide enough to let the market wiggle, so that you are not stopped out prematurely. Hence, the study of volatility offers a logical method of placing a stop-loss. Moreover, it is backed by statistics. This is also why volatility stop-losses are common among professional traders.
Here, you will learn everything you need to use this powerful stop-loss technique. First, you choose a way to measure volatility. Then, you decide on a safety multiple. Its purpose is to add a buffer for market noise. It is also a reflection of how aggressive you want to be in placing your stop-loss. Take the product of the volatility measure and the safety multiple.
The result is the stop-loss distance in terms price. The next step is to choose a price anchor. Finally, from the anchor price, project the stop-loss distance. That will help you find out where to place the stop-loss. The direction to project depends on your direction of your position. First Ingredient: Volatility Measure There are two common measures of volatility among traders. 1: Standard Deviation Standard deviation is the default volatility measure in the finance industry.
A statistical term that measures the amount of variability or dispersion around an average. Imagine a price series in which every single price data equals to its average. How would such a price series look like? Most charting platforms can calculate standard deviation for you. But it’s always good to know what goes into the computation. Work through this Excel guide by Adam Grimes to compute the standard deviation.