The ATR Trailing Stop is one way to limit losses and protect profits. A stop loss order is set a multiple of the Average True Range (ATR) away from the current stock price. As the price moves in the trade’s favor, the stop ratchets along with, always calculated from a better closing prices and never from worse closing prices. This mostly keeps from giving ground once its protected by the stop, except in the case of increasing volatility as measured by the ATR.
In backtesting, the ATR Trailing Stop reflects each stock’s unique daily price range. Hence it can fit each stock better than a dollar trailing stop or even a percentage trailing stop.
As with all trailing stops, the ATR trail never exits at the extreme of a movement. Hence it always gives back some of the profits.
The ATR stop amount can be subtracted from either the high, the close, or the low of the day. Each variation gives slightly different results. The important concept is to match the stop distance to the stock’s volatility and to move it along with improving prices.
