V.4:5 (177-183): Using basic statistics for stops by Robert W. Hull, Jr.

V.4:5 (177-183): Using basic statistics for stops by Robert W. Hull, Jr.
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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.

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