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How to set stop loss orders using the ATR indicator

If you are no stranger to playing on the stock market, it is worth being in the minority that earns money from it. This will probably mean giving up techniques popular among most investors, as well as many analytical tools. It may seem strange, but 90% of current traders make losses using them. So if you want to actually earn, it will be necessary to find your own solutions and show a lot of skepticism by approaching popular opinions.

Today we will reflect on the common stop lossclaim that orders should be set as close as possible to the opening price of the trade. As a result, our stock market investments may not bring the expected results.

Setting stop loss orders using the average range of price movement

We commonly use tight"stop losses"whose task is to limit the risk of transactions. However, what is especially manifested is in the lower time frames used by the typical trader in the stock market, and this is not very reasonable position management. The stop loss should be set in such a place that the transaction is profitable, and at the same time at a distance that gives us a low probability of its implementation by random movements. To achieve this goal, we can use the ATRindicator, also present on basic stock exchange platforms. However, it must be admitted that it is ignored by most investors.

Average True Range

Probably no trader on the stock market can do without ATR, regardless of the style in which he trades. Despite the serious-sounding name, it is a banal indicator in action, showing the average range of movement of the price over the last X candles. X usually amounts to 14.

Let's run a simulation: ATR We set it so that it reflects the average range of motion of the last 8 candles. Hypothetically, the result is 3.45. Thanks to this information, we rely on it when setting a stop loss order. Anyway:

  • Stop loss = 3.45 when stop loss is 1xATR
  • Stop loss = 6.90 when stop loss is 2xATR

So we can adjust the stop order to the market conditions, while we can be sure that it will not be executed by accident as a result of a large movement, quite natural for a given instrument.

Wrong stop loss setting generates unnecessary losses

The stop loss was intended to protect traders from losses, and paradoxically contributed to increasing their losses. Even if we approached trading the stock market strictly mathematically, a kind of slack, flexibility and readiness for unexpected, careless movements would still be required. So probably the worst thing you can do is to set such orders "like from the ruler". This is what the big banks on the stock exchange are counting on, which affect the exchange rates.

From this it can be concluded that the ATR multiplier should usually be greater than even a value of 1.5. The particular significance of this claim appears on a micro scale, i.e. on a low timeframe of 1.5 or 15 minutes, where you still have to reckon with a huge amount of randomness.

For example: if we decide to invest on a minute chart, the VALUES of the ATR multiplier, providing adequate space for trading, are 6, 8 or 12. In this way, the price needs to make 12 times more movement than its average value in a given market. This gives us a large margin of error.

Stop loss and take profit

We should be aware that investing in the stock market is unlikely to be possible in the long run without knowledge of issues such as stop loss orders, take profit and position management.

The stop loss/take profit ratio in the classic edition is 1:1, i.e.:

if the ATR was 3.45 and the top loss was 2xATR, i.e. 6.90, then in this case such a profit must be 6.90 away from the place where the position was opened.

More complicated orders may be as follows:

stop loss = 12xATR, TP = 8xATR (at closing 50% of positions), TP2 = 16xATR (at closing the remaining 50% of positions).

As you can see, the asymmetry that makes take profit closer than stop lossallows you to increase efficiency, while closing 50 positions opens the possibility of potential, extra profits. This type of solution requires an appropriate plan, whose task is to tell us when to leave the market closing the rest of the order. High ATR multipliers make it useful in 1 and 5 minute charts.

Stop loss settings should be tested on historical data

The style of our trading should have an impact on the adjustment of ATR multipliers, as well as the specificity of a given financial instrument. If we take into account the USD/JPY currency pair, which is known for its very sharp fluctuations in the exchange rate, then investing using a high multiplier seems to be fully justified. Conversely, investing in what's to say exotic and less impetuous GBP/CHF or AUD/NZD pairs using a high multiplier may prove unnecessary and counterproductive. This is because the positions we take will lose the chance for a favorable RRRrelationship, and it will take longer than required to realize only profits and losses.

For this reason, each of the settings should be tested in the process of bakctesting and on demo accounts to be able to assimilate the basics of the exchange, without risking losing real funds.

Author

  • Trainer in the field of finance, as well as a manager and speaker. She enjoys the development and success of her colleagues. He describes himself as an active, dynamic and organized person. Diagnoses the financial problems of his clients. After work, he rides a motorcycle and sails.

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