ATR CHANDELIER VOLATILITY EXIT MANAGEMENT

By Chuck LeBeau The return of volatility to markets with overnight index moves of more than 2% has smashed any illusions about the sustainability of longer term trend trading. Trade management now depends on understanding volatility so the trader can decide which level of price movement is unimportant, and which level is a signal that the short term trend has changed. These markets have renewed interest in Chuck LeBeaus ATR ratchet and Chandelier stop loss methods. Chuck LeBeaus Chandelier stop loss method rests on the ATR indicator. To understand the Chandelier method we must start with a better understanding of the ATR. Editor Trend changes and breakouts from periods of quiet sideways 'consolidation' are often seen to be accompanied by significantly greater daily price ranges - the whole market seems to become more 'active'. A most useful indicator that can pick up such changes in daily price ranges - changes in market volatility - is yet another developed by J. Welles Wilder in the 1970's, namely Average True Range (or ATR). The ATR was developed as the core element of Wilder's 'Volatility System'. ATR is calculated from a comparison of price highs, closes and lows. Hence it indicates changes in price volatility independent of the actual price. That is, it is equally effective whether the market in question has a trading price of a few cents or many dollars. This feature makes it suitable and often used for the development of trading systems which may be applied to many different markets, regardless of typical trading prices.

The ATR indicator can be and it used as both an entry and an exit indicator as well as part of some position sizing techniques. As a visual plot based indicator it is perhaps less useful

than when used in a scripted trading system. Metastock users have The Explorer and System Tester tools available to facilitate such a system. Entry Techniques Assessment / Setup: As noted above, moves either way out of quiet small price range sideways markets are often marked by much greater price ranges, i.e. greater volatility. Apart from visual inspection of charts, ATR can be used to pick such sideways periods by comparing shorter term, say a few days, and longer term, a few tens of days, ATR values. A lower or smaller value for the short term ATR indicates that the market is in a quieter period than usual. Such a result can point to a possible near term future breakout at the end of the quiet trading period. Conversely, relatively sustainable trends, rather than sideways markets, can be indicated by unusually high overall volatility! Assessing this situation is the reverse of the above. Namely, looking for a higher value (say possibly 1.5 times or more - do assess this for yourself) for the shorter term ATR when compared with the longer term parameter value. Volatility Breakout: By definition, one expects that the price range for any current day will be approximately 1 ATR in amplitude. If this was not the case, the value calculated for the ATR would be different! However, volatility breakouts' from quiet periods are often accompanied by significantly increased price ranges. For instance, if the market price suddenly changes by say 2 or more ATR, it is possible that the previously quiet market has broken out and is starting a new trend, up or down. Such Price/ATR comparisons can be used to generate an appropriate signal when coded into a MetaStock Exploration script or similar. Dips and Rallies: It can be useful (i.e. profitable) to buy into a dip within an existing up trend, if one has missed the original turning point or waited to confirm the trend. Again the ATR can be used to generate entry signals in this situation. A set of rules can be established along the following lines. If the close today is 2 ATRs greater than the 30 day moving average and 2 ATRs or more below the close 7 days ago, then buy tomorrow if the prices raise 0.8 ATRs above today's low. These rules and values are given as examples only, but the concept confirms that the longer term trend is up but the market in question is in a dip within the up trend. ATR Exit Strategies The ATR is multifunctional - it can be useful for assessing both entries and exits. Now we all know that the exit plan and execution is at least as important as the entry, if not more so. Simple approach: The simplest approach using the ATR is more of a trade tracking or profit dollar objective plan. Many of us look at a trade and assess from various recent historical values such as support and resistance lines, where appropriate exist points may lie. Using recent price movements one can assess through some short term back testing and/or optimisation possible ATR multiplying factors that can flag typical pullback points from the chosen entry points, dips and rallies. Chandelier exits: Another approach for trending markets uses somewhat that same thinking with some scripting involved. Such approaches are usually given the Chandelier name, owing to the fact that the exit 'hangs' under the basic market price bars. At least two price points can be used as the anchor for the ATR value - the day's close or the day's high being the two most popular and commonly used. Now coming back to the earlier information, recall that (by definition) one expects the price range for any one day to be about the current ATR value. If that is not the case on the day, something has changed in that particular market and hence one needs to act appropriately. In the case of the Chandelier Exit, typical exit values for the NEXT day or period are as follows: (a) Exit at the highest high since entry minus 3 ATR

(b) Exit at the highest close since entry minus 2.5 ATR Referring to (a): the multiplier can be anywhere between about 2.5 and 4. Welles Wilder in his original writings in the late 1970's, recommended a range of 2.8 to 3.1, however one must test values in the current market to determine suitable values. Referring to (b): from the original definition of ATR, it is obvious that this value ought to be about 1 ATR less than those for (a). Note - this exit approach on its own is also sometimes called a Yo-Yo Exit. Do note that most exit strategies using the Chandelier approach use BOTH (a) and (b) above. Such an approach will help protect against unusually large short term reverse direction spikes in volatility. As with all trading and trading systems including 'semi-mechanical' systems, the major requirement is money management - after all the gaining and retention of money is the reason we are in this game! ATR Volatility Breakout Entry trigger The commonly accepted indication of a Volatility Breakout is a sudden increase in the daily price range and hence the ATR for the stock in question. This is most obvious when referring to the chart labelled 'ATR Entry' in the period around late November. A long period of very low daily price ranges was followed by a sudden increase in both price range and price itself, quite easily seen on the chart and shown by the jump in the ATR indicator plot values. Using a multiplier of two (i.e. 2 x ATR), the ATR entry trigger occurs a couple of days after the initial volatility jump, as indicated. A less dramatic but nonetheless significant similar period can be seen in mid January.

Chandelier Exit trigger The Chandelier Exit trigger is an exit trigger particularly suited to a volatile market and hence is of current interest. Many variants of it have been produced, but perhaps one of the more useful from a charting perspective is that indicator recently written by Barry Marx and given on the MetaStock email list. The indicator code for MetaStock appears on the

http://www.guppytraders.com.au Data Exploration Formulas entry page. The item is called Chandelier Exit variation. The calculations are exactly the same as those noted in the 'ATR Exit Strategies' considered in previous articles, namely: (a) Exit at the highest high since entry, minus 3 ATR, OR (b) Exit at the highest close since entry, minus 2.5 ATR, whichever is the greater of the two. When an exit is triggered (that is the exit stop is hit) per the parameters above, the value of the Chandelier function is reset and hence drops. Until that point, this variant of the plot continues on flat or rising but without dropping, thereby usually eliminating small variations in price range. Do note that the stock price can FALL with little price volatility and hence create a trap for the unwary if reliant entirely on an ATR based exit trigger!! The chart labelled 'ATR / Chandelier Exit' shows both of the above descriptions.

Other more standard Chandelier Exit indicator plots give the exit price for the next period /day, each period / day. That is, if tomorrow's close is below the Chandelier Value given at the end of trading today, an exit trigger is flagged. Heres a variation MODIFIED ATR WITH TRAILING STOPS with Metastock coding. Change the tallow highlighted ATR values to suit your requirements.

period:=Input(14 :,1,100,5); atrfact:=Input(1 :,1,10,3.5); HiLo: =If (H-L<1.5*Mov(H-L,period,S),H-L, 1.5*Mov(H-L,period,S)); Href: =If (L<=Ref (H,-1), H-Ref(C,-1), (H-Ref(C,-1))-(L-Ref (H,-1))/2); Lref: =If (H>=Ref (L,-1), Ref(C,-1)-L, (Ref(C,-1)-L)-(Ref (L,-1)-H)/2); diff1:=Max (HiLo,Href); diff2:=Max (diff1, Lref); atrmod:=Wilders(diff2,period); loss:=atrfact*atrmod; trail:= If(C>PREV AND Ref(C,-1)>PREV, Max (PREV, C-loss), If(C<PREV AND Ref(C,-1) <PREV, Min (PREV,C+loss), If(C>PREV, C-loss,C+loss))); Trail
INDICATOR REVISION CHANDELIER EXITS Chandelier exits are a variation of Average True Range stop loss approaches. They are called Chandeliers owing to the fact that the exit 'hangs' under the basic market price bars. At least two price points can be used as the anchor for the ATR value - the day's close or the day's high being the two most popular and commonly used. Traders expect the price range for any one day to be about the current ATR value. If that is not the case on the day, something has changed in that particular market and hence one needs to act appropriately. In the case of the Chandelier Exit, typical exit values for the NEXT day (or period) are as follows: (a) Exit at the highest high since entry minus 3 ATR (b) Exit at the highest close since entry minus 2.5 ATR Referring to (a): the multiplier can be anywhere between about 2.5 and 4. Referring to (b): from the original definition of ATR, it is obvious that this value ought to be about 1 ATR less than those for (a). Note - this exit approach on its own is also sometimes called a Yo-Yo Exit. Do note that most exit strategies using the Chandelier approach use BOTH (a) and (b) above. Such an approach will help protect against unusually large short term reverse direction spikes in volatility.