The Volatility Quotient (VQ) is recalculated in TradeStops every week. Most of the time, the change is small. But sometimes the change can affect your trailing stop.
We use a rolling 3-year price history of a stock to determine the VQ. Our algorithms look at daily prices, but perform the calculation on a weekly basis. Because we’re using a 3-year history, the weekly changes in the VQ are not usually that great.
But there can be exceptions. Here’s an example.
This is the chart of Tesla (TSLA) from 2015. We know the stock is a volatile one, and that is reflected in the ups and downs of the price.
The stock was trading in the SSI Green zone and SSI Yellow zone during all of 2015. The SSI Entry signal had occurred back in June 2012, and the high price for TSLA of $286.04 occurred in September 2014. The SSI Stop price at the beginning of 2015 was $171.69. This stop price was in effect all the way through the first week of August.
But look at what happened in the second week of August. The SSI Stop price moved up for no apparent reason. The SSI Stop price moved up to $178.64.
The stock didn’t set a new high. There was nothing in the price of the stock itself that caused the SSI Stop to move higher.
But look all the way to the bottom. That bottom chart is the historical VQ of TSLA. In August of that year, the VQ moved from 41.64% down to 37.58%. That means the volatility contracted almost 10%.
And that was what caused the increase in the SSI Stop price. The new SSI Stop price of $178.64 was still based off the most recent high from September 2014. Because the volatility decreased in August 2015, the SSI Stop price had to move higher.
Next, you’ll notice that the VQ increased back to its normal VQ just about 6 weeks later in September. Yet, this had no change on the SSI Stop price. It remained at $178.64.
The TradeStops philosophy is to never lower the trailing stops based on changes in the volatility of a stock. So even though the VQ returned to the 41% range, the stop was not lowered back to where it was in early August.
This situation does not happen often. And it’s most likely not going to happen in stocks that are low or even medium risk. But it can happen in high risk stocks and stocks that are deemed to have sky-high risk.
If you have any questions, please contact our Customer Success team.
Tom Meyer
Education Director, TradeStops
