Big Bamboo: Refining Stop Strategies

BHH over at his blog IBDindex has published some graphs of what happens when various percentage and ATR stops are used with the Big Bamboo system.

The study demonstrates how percentage and Average True Range stops affect Net Profit, Win%, Average Trade, and Profit Factor.

B’s post is here: Big Bamboo Stop Study

The value of using a multiple of ATR for a stop is that the stop will constantly adjust itself for volatility,  and win percentage will theoretically improve. The drawback to this method is that during periods of high volatility, position sizes will be smaller than with a fixed percentage stop, which will mean profits will be smaller on winning trades.

In many ways, the ATR stop vs. Percentage stop is as much about the trader as it is about the system. If one has a large appetite for risk, and does not need to be right more than 50-60% of the time, he would probably rather have the large profits associated with percentage stops. However, if one is more comfortable with the odds of winning 70% of the time, and can accept smaller average winning trades, an ATR stop may be more appropriate.

Finally, Damian from over at Skill Analytics reminded me that traders can get hit with larger than expected losses when using ATR stops. This would occur when volatility has died down, which would cause the ATR stop to get tighter and tighter. If a system is using a percent-risk formula for position-sizing, as the stop gets tigher, it is buying bigger and bigger positions. If volatility suddenly returns, the system may experience some large losses, until the ATR stop has time to catch up with the market volatility.

Sometime this week I will be running hindsight trades on the Big Bamboo to see what the current results would have been if it were using ATR stops.