Over the course of little more than a decade, TradeStops has changed the way individual investors look at risk in stocks and portfolios. In developing TradeStops, we introduced new terms into the investing world. The Volatility Quotient (VQ) and Stock State Indicators (SSI) are the two most-used terms in TradeStops. Sometimes, it can take a little while to fully understand their meanings.
Case in point… Last week, we introduced you to our “Low Risk Runners” strategy. In this strategy, we look for stocks that have already started solid uptrends and then pulled back in price just enough to still be interesting – but not so much as to be in danger of collapse.
In the above article, TradeSmith commented that these stocks “… have the potential to move considerably higher while taking a smaller amount of risk than normal.”
Some of our readers were confused with this statement about taking a smaller amount of risk. To help clear this up, we’ll use the same examples of Intel (INTC) and Visa (V) that were in the original article.
When a stock generates a new SSI Entry signal, it is then considered to be in the SSI Green Zone. The stop loss of a stock from the SSI Green Zone is the most recent high price of the stock (usually that’s the day the stock triggered the SSI Entry signal) minus the current VQ%. If stock XYZ triggers a new SSI Entry signal at $100, and it has a VQ of 15%, then the SSI Stop would be $85.
The SSI Yellow Zone is defined as a little more than half way between the most recent high price and the SSI Stop price. So in the case of XYZ, the SSI Yellow Zone would be triggered when the stock moves down and closes around the $92 level (this is approximate as the actual SSI Yellow Zone calculation is proprietary).
What does this mean to you as an investor? If you were to buy XYZ when it was in the SSI Yellow Zone, and you used the SSI Stop as your trailing stop, you would only have $7 of risk on the table rather than $15 of risk when the stock was trading at $100.
If XYZ moved back above the $92 level and into the SSI Green Zone, it will have shown positive strength that triggers our Low Risk Runner strategy, but investing in XYZ at this point in time would have less at risk because the SSI Stop remained at $85.
Let’s take a look at INTC. When INTC hit a high of $36.32 in October 2016, the SSI Stop was $30.14. The SSI Yellow Zone was at $32.61. The VQ for INTC was 17.0%.
At the time INTC moved back up into the Green Zone, the price was $33.32. The SSI Stop was $30.15. That meant an investor in INTC would have taken only 9.51% of risk. With the VQ at 17%, investing in INTC and using the SSI Stop, the risk in INTC was only 56% of its normal risk.
V originally triggered an SSI Entry signal in May 2009 at a price of $15.96. The VQ of V at the time was 51% (don’t forget that we were coming off the financial crisis at that time). The SSI Yellow Zone was $11.08, and the SSI Stop was $7.82.
With V at $18.27 and the SSI Stop at $14.47, the risk in V was only 20.3%. V spent most of the next year in the SSI Yellow Zone – but never stopped out. It has had a few forays into the Yellow Zone over the past several years, but each time has continued moving higher.
Just because a stock is in the SSI Yellow Zone that doesn’t mean it’s going to automatically stop out. The Yellow Zone is within the normal risk of the stock – it has just dropped some. When it moves back into the Green Zone, it can represent an excellent opportunity to invest in a stock that is still in an uptrend, but with less risk.
And that’s what TradeStops is all about. Make More, Risk Less.
Education and Research Specialist, TradeStops