Day Trade Adjustments for Volatility

stock trading todayHow do you determine share size per trade? Is it documented in a written trading plan?

Day trade and risk go together, it’s tough to say one without the other.

The problem for most new day traders is they never learn to adjust risk with volatility. A $500 risk is not the same in every stock or from day-to-day.

Stocks have different volatility, known as average true range. This is the amount price action fluctuates from high to low (on average). New traders should assess risk tolerance, capital and decision making ability and coordinate these resources with volatility.

The truth is, new day traders can’t handle faster, wider movements. They have not learned to make good decisions yet. They don’t have enough experience.

This is one of the top reasons talented day traders fail. They trade too much volatility too soon. They are focused on potential profits before learning how to handle risk.

Day Trade and $500 Risk

I can’t tell you how many traders want to day trade $NFLX simply because it moves a lot. There is nothing wrong with this, if it fits your skills and risk parameters. A day trade in this stock with a risk of $500 can be wiped out in 5 minutes without choosing the correct combination of share size to stop-loss target.

From January 21-February 9, 2015 $NFLX had a 14 period average true range of @$16 per day. This means on average, over that 14 day window, the distance between the high and low was $16. For the majority of the month of March 2015, the ATR over the same averaged period was $11.

Or $5 less per day from high to low. The swings to day trade were “less volatile.”


$NFLX Weekly Chart

As volatility rises in your stock, you can reasonably expect wider swings from entry to stop-loss target. This means you can still risk $500 but you would allocate fewer shares to compensate for the difference.

Could you trade with a tight stop and usee the same shares? Yes, but you are setting yourself up to get stopped out on normal price action. You need to set your stop outside of this noise.

Day Trade Volatility Adjustment #2: The CBOE $VIX

This chart of the CBOE Volatility index demonstrates expected future volatility. It is also known as the fear index.



As the $VIX rises, volatility rises and selling pressure tends to increase.

Day trade lesson: You should monitor the reading of the $VIX and the trend of the $VIX so you can adjust share size to be in line with accepted risk. *This also means short-selling if there is an obvious up trend in the $VIX is a good play (assuming the stock in not in a valid uptrend)

Rules to Protect Capital While Taking Advantage of Wider Price Swings

#1: Pick a dollar amount you are willing to risk and then choose the correct amount of shares. The sign of an amateur is a day trader who trades the same amount of shares every trade. Reverse engineer the trade. Accept the risk in then determine how many shares based on the difference between your entry price and stop loss.

#2: Accept the risk and stick to it. Putting on a trade and accepting the risk is not the same thing. You are guilty if you have ever moved a stop loss. If your stop loss is going to get hit, let it get hit. Exit the trade and simply look for another spot to enter if the trade scenario is still valid. Under no circumstances should you add to a losing trade-especially in this environment with the increased volatility.

#3 Take quick profits: Increased volatility translates into wind-fall profits. Well executed trades can pay quickly. Be smart, don’t be greedy. You are a swing trader not an investor, take the profits and move on. If your profit target is reached in two days instead of seven book it!

#4: Learn to short-sell or stay out of a market decline. If the concept of earning money as the market moves lower is un-American to you or you simply don’t understand how it works, step aside and find a stock that has a bullish edge. You don’t need to be involved all the time.

Recap: Increased volatility means increased opportunity. If you are prepared with correct risk and disciplined, this can be an exciting time to day trade. If you are a new trader and not sure how to recognize this scenario make it a point to watch the $VIX.  As it rises the average range of stocks increases. Adjust your share size lower in sync with a rising $VIX and you will have a sound money management plan.

Disclaimer: The lessons here are guidelines to consider for your unique resources and skills. All lessons and tips need to be considered in context. Good trading education provides a foundation for you to adapt into your trading plan.


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Leave a Reply 7 comments

pipville Reply

Great article

    Brandon Reply

    I agree with everything except rule number 3. I think that one thing that you didn’t note is that with increased volatility you should probably reduce your position size because you need wider outs. With wider outs, you also should have proportionally greater price targets. I think that is probably one of the biggest hurdles many new traders have to get over (and all of the traders that are stuck at the intermediate level) is not taking profits too early, regardless of how quickly and how strong the move is.

      Pete Renzulli Reply

      Hi Brandon
      thanks for the comment.
      You are right. I will be expanding on that concept in a future post. Adjusting share size to a wider stop-loss is absolutely the correct method.
      Have a great day

Daniel Reply

Hi Pete
I have one question: why shouldn’t a day trader hold his trades like an investor, with sound risk and money management, in order to maximize profit ?

    Pete Renzulli Reply

    Hi Daniel
    this is a good question and it really applies to two things: realistic intra day opportunities and style of trader.
    Day trading is not investing. Not even close. An investors goal is to buy a shares of a company and hold through price fluctuations. Traders are buying shares with the intention of exiting relatively quickly (quickly is relative to the trader). Many traders choose to earn money with many trades and make money on volume. This requires discipline especially in the area of avoiding a big loss.

    Intra day opportunities for investor style trades require trading stocks that have wider ranges. Most active day traders do not buy and hold all day. Do they want to maximize what they earn? of course but their style and ATR of the stocks they choose to trade come into play.

Jon Reply

I’m learning how to day trade and in formulating my day trade plan. I currently trade options. What are your thoughts on trading weekly options to break-even on a trade. I know that stops should be well defined. But it just crossed my mind that you could sell weekly options to break even on the stock. This would involve tying up capital into a stock with options premium, but I’ve been trying to research this idea and haven’t found any info on it yet.

    Marian Boyle Reply

    Hi Jon,

    I just want to make sure I’m understanding you. You want to buy the stock and sell a higher call against the stock?


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