Bulkowski’s Stop Placement

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What I Use

Most often, I place a stop below the prior minor low or horizontal consolidation region, usually the one closest to the price action. Then I calculate a volatility stop to be sure the one I chose (regardless of the method) is not too close. If it is, then I look for another stop location farther away. Sometimes, I will just use the volatility stop price.

If no minor low is available, I will calculate a Fibonacci retrace of the prior move up and consider placing a stop below the 62% retrace price. If that is too far away, then I will usually defer to the volatility stop price.

The preferred order is: minor low stop, volatility stop, Fibonacci retrace stop.

I will always place the stop below round number support (I use oddball numbers 9.93 instead of 10, for example). If a gap exists, I will place a stop below the lower gap edge.

Minor Low Stops

The figure shows a common stop placement technique. When price makes a new high, raise your stop to just below the prior minor low.

For example, point A is a minor high and point B is a minor low. Suppose you bought the stock at point D. Price has climbed to A before retracing to B. When price at C climbs above the minor high at A, then place your stop just below B.

This technique works because peaks and valleys (minor highs and minor lows) act as support and resistance zones. When price moves back down, it often stops at the price level of a prior peak or valley. A stop placed below the valley will stop you out only if price continues down. That’s how it’s supposed to work. Most often, though, price will resume the rise before hitting the stop.

Volatility Stops

I read about this in Perry Kaufman’s book, A Short Course in Technical Trading. The idea is similar to my beta adjusted trailing stop (BATS) that I introduced in an article for Technical Analysis of Stocks & Commodities magazine in January 1997. Stop placement was done using beta (a measure of volatility) and the current price.

In Kaufman’s technique, compute the average daily high-low price range for the prior month, multiply by 2, and then subtract the result from the current low price.

The following table shows an example based on Exxon Mobile’s stock (XOM) during July 2005.

The difference column is the intraday high minus the low. The average of the differences for the month is $ 1.15. Multiply this by 2 to get the volatility, or $2.30. Based on the volatility of the stock, you should place your stop no closer than 56.45. That’s $2.30 subtracted from the current low (58.75 on July 29). If price makes a new high, then recalculate the volatility based on the latest month, multiply it by 2 and subtract it from the current low. This method helps you from being stopped out by normal price volatility.

Recent testing has shown that a multiplier of 2 is best (it used to be 1.5). Also, the lookback should be 22 price bars. That is about a month’s worth of price data that you average.

The average high-low volatility measure (HL) performs better than the average true range (which includes gaps, whereas the HL method does not) and better than standard deviation. Standard deviation performed the worst of the three methods in nearly all of the tests.

For the test, I used about 100 actual trades I made from 1/1/2003 to end of 2005 and compared the performance of the three methods using various parameters to my actual results. I found that when using the HL method (with 2x multiplier and 22 bar average), the average giveback before being stopped out after price peaked is 6.88%, which is less than the 10% maximum I consider acceptable. The HL system made the most money and improved on the profitability of the trades 48% of the time.

Unfortunately, all of the stop methods tended to take you out of the best performing trades prematurely, so you can't use the method as the ONLY way to exit a trade. Discretionary timing the exit improved performance substantially. That means correctly choosing when to use the HL stop and when not to is vital. Use a volatility stop only when other stop methods would place the stop too far away.

Other Stop Locations

The following sites make for good stop locations.

Gaps

The above picture shows two additional stop locations. The left image shows a price gap. Notice how the minor low at A stops above the gap. Providing the gap isn’t too wide (to keep the potential giveback small), a good stop location is a few cents below the lower side of the gap at B.

HCRs

HCRs are horizontal consolidation regions. They are small knots of price congestion like that shown in the above chart. HCRs usually have flat tops, flat bottoms, or both, or horizontal price movement that shares a common price. Place a stop a few cents below the HCR at C like the figure shows.

Round Numbers

Price often pauses or reverses at round numbers. A round number is 10, 15, 20, and so on. Novice traders don’t place a stop at 9.93, they place it at 10. Thus, oddball numbers like 9.93 makes for good stop locations. Let everyone else get stopped out at 10 while you remain safe a few pennies below.

Chart Patterns

The apex of ascending, descending, and symmetrical triangles are common support and resistance areas. They make for good stop locations as do the bottom of many chart patterns. Often, price will rebound before piercing the bottom price level of a chart pattern.

Fibonacci Retracements

Fibonacci retracements make excellent stop locations. Look at the below figure for an example. When price swings from A to B, it often retraces (drops) a portion of the prior rise. In this example, the retrace is 50% of the rise from A to B.

Measure the swing from the prior minor low (A) to the prior minor high (B). Multiply the distance by 62% and subtract it from the price of the prior minor high. Place a stop just below the resulting value. You will find that price often retraces 38%, 50%, or even 62% of the prior rise. If price drops more than 62%, then price is likely to continue moving down. Thus, the 62% retrace amount represents a good stop location.

More recent testing shows that a 67% retrace will keep you safe two-thirds of the time.