Using basic statistics for stops by Robert W. Hull, Jr.
The primary purpose of this article is to use basic statistics to measure the degree of price volatility that
can occur on a daily basis in the copper market. These measures can then be used to place a stop or limit
order that takes into account these natural daily price movements. The statistics that will be used will be
the mean, the standard deviation, and the coefficient of variation.
Many potentially profitable trades have ended up losing money or cutting profits short for the trader, as
the market has traded to a price where the trader had made a decision (a stop) to exit the market. This
decision may have been made and executed by the trader when the market moved into an uncomfortable
range, or it may have been the result of a stop placed with a broker. It is common to hear someone say
that they had given up a position that would have been profitable as, shortly after their decision, the
market moved in the originally anticipated direction.
The price chosen by the trader as the stop will depend on the current price level and the amount of risk
the trader is willing to accept. This risk will be the dollar amount that either the individual feels he can
afford to lose, or the size of the reduction in potential profit he risks giving up. This subjective approach
to determining risk can cause a problem in that the natural volatility of the market might not be taken into
account. If his intuitive sense of risk is in disagreement with the natural movement of prices, losses or
profit reductions may occur.