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Quick Take: DVT-A New Trailing Stop Concept

August 8, 2009

Note: Quick Takes will be short articles introducing new ideas or concepts that haven’t been tested. It is designed to help inspire your own personal systems. If you wish to demonstrate the results of Quick Takes ideas, your results will be published on this site subject to verification.

I think it is always important to look at two sides of the market coin: 1) trend and 2) countertrend. To be consistently successful, you have to be able to do both because both strategies have a notorious habit of going in and out of favor in an unpredictable and sudden manner.  We have examined numerous countertrend systems, and given the strong market rally  i think it is worthwhile taking a better look at trend systems. I have not had the time to test this idea yet, but i strongly believe that it will work well.

The DVT would be a trailing stop very similar to the Chandelier Exit published by Chuck LeBeau. But there are a few  differences:

1) it has a trigger:  The entry is triggered by a new “n”-day high or low with a lookback of “k” days. That is, the stock or ETF has made a new 100-day high, and no new 100-day highs were achieved within a lookback of 20 days. My recommendations are for default n/k settings of  25/10, 50/15,  100/20 and 252/40. This prevents whipsaws once the stop is triggered because re-entry is not permitted unless it newly satisfies either the long or short conditions.

2) it has an intial stop: this is suggested to be 1/2 the trailing stop. The default settings could be 2xATR (average true range) and 4x ATR. The trailing stop is triggered when the stock rises (or falls in the case of shorts) an amount equal to the intial stop. Thus if the stock goes up 2 ATR, the trailing stop is triggered, ensuring a maximum loss equal to the initial stop.

3) it has a variable trailing stop:  Here is where it gets interesting– as the trend gets stronger, the stop gets tighter. Most of us (including myself) have experienced the pain of watching unrealized gains evaporate after a stock goes parabolic. Moving averages and other trailing stops cannot protect you from this because they do not adjust rapidly enough. Therefore i propose the following adjustment using a default 4xATR trailing stop:

DVT Trailing stop= (1-(RSI14/100 or DVS reading)) x 2 x default ATR(4 in this case) below the current level

for shorts: DVT Trailing stop= (1-((1-RSI14)/100 or DVS reading)) x 2 x default ATR(4 in this case) above the current level

As a general preference i would choose the DVS (the stretch indicator) over the RSI14. But to keep it simple if the RSI 14 is 70 then the DVT would be:    (1- 70/100) x 2 x4= 2.4  So as the security gets stronger, the stop gets tighter—-theoretically preserving your gains more effectively.

As with all trailing stops, if you were triggered long, the stop would be calculated every day but could never decrease, and if you were short, it could never increase. As a final suggestion, i believe that the following settings are appropriate for various instruments:

1) ETFs, broad indices, or commodities: 100 day high or low trigger with a 20 day lookback. 4 ATR as a trailing stop, 2 ATR as an initial stop.

2) individual stocks: 50 day high or low trigger with a 15 day lookback. 4 ATR as a trailing stop, 2 ATR as an initial stop.

3) high relative strength stocks: 50 day high or low trigger with a 15 day lookback. 3 ATR as a trailing stop, 1.75 ATR as an initial stop.

One Comment leave one →
  1. trailingstopsblog permalink
    June 17, 2010 8:39 am

    Nice article. I think that trailing stop can be quite good for investors who may not have enough discipline to lock-in gains or cut losses. It removes some of the emotion from the trading process and offers some capital protection automatically.

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