Contributed by John Slauson
A lot of traders focus on perfecting the perfect entry signal. The thinking is "If I can time my entry well, then a profit is a natural by-product." However, anyone who has traded knows this could not be further from the truth.
I believe many systems could be improved with effective stop losses. It would not surprise me if a monkey throwing darts at a stock chart could generate entry signals that turned consistent profits IF an effective stop loss were used for exits.
A little-known indicator in MetaStock is the IntelliStop. I developed this indicator about 10 years ago to be used as a universal exit signal. It is essentially a trailing stop with a unique twist; it automatically tightens and loosens based on directional volatility.
Volatility (as measured by standard deviation) is non-directional - meaning a sharp upward move has the same impact on the volatility value as a sharp downward move. Intellistops separate upside volatility from downside volatility. Why?
Upside volatility is considered a positive condition for long positions; whereas downside volatility is a negative condition. High upside volatility will cause Sell IntelliStops to tighten in anticipation of a return to normal volatility thereby locking in gains. A sharp downside pullback counteracts the temporary increase in volatility generated by a sharp upside move.
IntelliStops were created with the following principles in mind: let losses die quickly (play defense first), let profits live long, and strive for average profits that outpace average losses by a factor of two. Are IntelliStops the perfect application of this principle? No. But they can be effective.
The following chart shows the Adaptick IntelliStop indicator (Level 2 setting) overlaid on the QQQ. Note that an IntelliStop only resets when it is hit, as illustrated below. This is standard trailing stop behavior. The circled bar penetrated the active stop value, causing it to reset/recalculate on the current bar's low.
To plot the Adaptick IntelliStop indicator on a chart, simply drag and drop the indicator named "zAdaptick - IntelliStop Buy (1,2,3,4, or 5)" or "zAdaptick - IntelliStop Short (1,2,3,4, or 5)" from the Indicator Quicklist and drop it on top of the price plot.
An intellistop should be used the same way you would use any other stop. Using the chart above as a reference, here is an example: Let's say I purchased the QQQ at $68.50 using the monkey's dart and the current price is $73.03. I want to lock in my unrealized gains of $4.53 with an IntelliStop. The current value of the IntelliStop is $71.34. I could place a Good-til-Canceled (GTC) Sell Stop Loss order as shown below (This is Fidelity's order ticket; yours should be similar).
After placing a Stop Loss, you will need to monitor the IntelliStop closely in MetaStock in order to adjust it as necessary. Of course, the stop will never go down in the case of long positions, or up in short positions.
So take a look at IntelliStops. They may improve the performance of your trading systems.
But remember, trading isn't monkey business.
About John Slauson
John Slauson began his career with MetaStock in 1988. In 2000, he left and started Adaptick, a company that provided training and developed popular MetaStock add-ons ICE, FIRE and PowerStrike. Over the years, he's worked closely with industry experts like John Bollinger, Steve Nison, John Murphy, and Greg Morris. In 2008 he returned to MetaStock as a Product Manager.