The Gain of the Year : 1-ATR

It may be surprising but the main profit I made this year isn't the +380% performance I achieved on stock indices the first five months. It lies in my stop loss system. Let me detail a bit further. I use so-called "Volatility stops" based on the daily Average True Range (ATR) technical indicator. Technically, the ATR is the exponential average of the daily range (high minus low) taking into account the opening gaps, in more "normal" words it measures the daily volatility in points for a given market. For instance as I write the ATR(14 days) of the EURUSD is at 0.0152, meaning the average daily move for the pair from high to low is of 152 pips.

When trading, what you want to avoid is to be stopped "by the noise" : have your stop loss triggered just to see the market ultimately going in your direction... without you... Being right and lose money is definitely the worst thing. The trick is to try to define a stop loss level that's beyond the noise level, that is trigerred only when you're wrong on your position. Roughly, if you assimilate 1 ATR to a standard deviation and assuming some normal distribution (which is contested but that's not the debate here today), I'd say a fair stop level to avoid the noise is probably between 2 and 3 ATR.

For a while, I'd been using myself a 3-ATR stop (trailing or not depending on the specific case) until I looked at my blotter and analysed my own past trades. I've found out that almost all (more than 95%) of my winning trades had a worst adverse movement below 2-ATR. In other words, if I had a 2-ATR stop instead of 3-ATR, most of my winners would have remained winners and almost none of them would have been stopped. The conclusion then was obvious : I switched and now I'm now using a 2-ATR stop loss system and that's how I'm now saving 1-ATR on all my losers, which is a really huge gain.

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FYI As this post is published: SPX 1118 // SX5E 2748 // NKY 9603 // DAX : 6244 // EURUSD 1.2356 // USDJPY 91.16 // XAUUSD : 1259