The volatility stop is probably one of the greatest indicators for the trend trader. It is a stop loss that takes into consideration stock volatility. The average of a specific trading period is calculated to plot placement of a stop loss order. The technical indicator is plotted on a stock chart to define trends, and changes in the direction of a specific market or security.
Advanced traders know that a selling point must be defined in order to minimize the risk factor of the trade. While placing a stop loss can be simple as finding support and resistance levels, it doesn’t offer the same flexibility as a volatility stop. Things can become a little more complicated if there is an uptrend. Catching a major stock trend is fairly simple, however as the stock moves up support and resistance levels are not clearly defined. We need some way to systematically move stops accordingly. There is a sweet spot between risk and reward.
Prevent Selling Too Soon
Often times traders will sell too soon, and miss the majority of trend. This can make a difference between having a losing year and a winning year on the books. Other times traders will catch the trend and be profitable, and refuse to sell only to watch the trade turn into a loss. The volatility stop solves this dilemma.
As you realize by now, stock trading is the fine art of buying and selling AT THE RIGHT TIME. Jesse Livermore always calculated the factor of “time” in his trading. If you can understand how the volatility stop works, it can give you a signal of exactly when to sell to preserve profits, and keep losses small.
Give The Trade Some Breathing Room
A volatility stop or Vstop, gives the trade room for volatility or degrees of freedom per se. Looking at the chart below of the Gold ETF, we enter the trade by buying at the breakout level. We can simple place a stop loss order just below the breakout level. However as time goes by, you must move the stop up, or place a trailing stop. The question is how much to move your stop? How far behind should the stop follow the price action? If you place the stop too tight you have the risk of getting stopped out prematurely, and missing the rest of the trend. With the volatility stop indicator, you can clearly see where the stop could be placed. These lines calculate the volatility and plots lines to define stop loss placement.
The V-stop line gives the stock “room to move” as the stock price climbs. Some traders may argue that simply putting a standard trailing stop of about $5 behind the price action will suffice. However, they fail to consider that, as price increases, and volatility increases, a standard $5 trailing stop will become “tighter” as the trend moves up. This will result in being stopped out of the trade prematurely. Resulting in a missed trend. We want to be on the trend till it ends.
Again placing that stop is crucial in stock trading. Too many traders don’t pay attention to the placement of the stop loss order. It’s such a simple concept, but when analyzed and studied, is perhaps the most powerful tool in the trading arsenal.
Many Uses Of the V-Stop Indicator
There are many uses for the V-stop indicator. Looking at the stock chart above, this indicator defines when the stock is an uptrend or downtrend. When the price action trades above the v-stop line, it is in a bullish uptrend cycle. When price action is trading below, we can consider it a bear or downtrend cycle. Some traders, use the v-stop to enter and buy when the price action crosses the v-stop indicator line from below and starts trading above it. This may signal the beginning of an uptrend.
Remember, that the v-stop indicator is only one of the many technical analysis methods that are available. There are many ways to interpret and use this indicator to enhance stock trading performance. The uses, of this indicator if entirely at the discretion of the trader. It’s up to the trader to become creative in using this tool.