Protecting Profit During Volatility

Posted on Thursday, December 20, 2018 at 1:48 PM

This year has been quite volatile, possibly the most volatile ever for stock indexes. The first and fourth quarters saw average day ranges that spanned nearly twice the norm. Day ranges have been closer to the length of a historic average week. When the moves are so extraordinary, risk doubles, as does profit potential. An average of 20-day ranges is adequate to be current with volatility. It is important to be current with range length because it is frequently used to calculate risk and profit targets.

In the daily futures class we search for trades where trend potential is high. We endeavor to enter at prices where the reward is three or four times risk. One of the more effective methods we use involves average day ranges or ATR (average true range).

For example, let’s say we are bullish and have chosen a level to buy the market. After taking a long position the risk (stop loss) is immediately entered at 25% of an average day range below the entry level. The first profit target is at 50% of a day ATR higher. The first objective is not where the trade is exited. When the first target is tested, the stop loss is moved to the entry price. This strategy is designed to reduce risk to zero as soon as the market begins to trend. Assume the profit objective is 100% of a day ATR above the entry price. As the market moves higher, trail the stop at 25% of a day ATR. With this method you can protect profit in case program trading and panic instigate big swings up and down.

Program trading and social media have added to the volatility. These days markets frequently reverse in the blink of an eye. Now more than ever it imperative to define risk immediately after executing a trade. Having a methodology that locks in profit reduces risk and stress as well as helping to avoid the panic trade.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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