1989issue C111-5
Constructing cycle-aged volatility trailing stops
A trailing stop can be assembled from two sequential pieces: a first offset taken from half-cycle average daily volatility, then an age schedule that closes the leftover gap when the position reaches the half-cycle horizon. Cycle length can be counted swing to swing or measured with maximum entropy spectrum analysis.
- A generalized trailing stop has two parts: an initial offset large enough for ordinary price noise, and a later tightening schedule that reduces remaining room after a significant reversal.
- The first stop uses average daily volatility from the most recent half of the dominant cycle, subtracted from the entry day's low for a long or added to the entry day's high for a short.
- Stop acceleration follows trade age so the remaining extreme-to-stop gap is fully removed when age equals the half-cycle horizon.
- Underestimating the dominant cycle tightens the stop before price turns; overestimating the cycle is described as the smaller penalty.
Two construction elements
A generalized trailing stop is constructed from two elements. The first is an initial offset large enough for ordinary price noise. The second is a later tightening schedule that reduces remaining room after a significant reversal.
As an editorial framing, treat those elements as two sequential clocks rather than one fixed distance. First park the stop beyond half-cycle average daily range so ordinary noise cannot force an exit. Then close the leftover gap on a linear age schedule that finishes when the position is half a dominant cycle old.
In this construction a trailing stop is a following exit that starts offset from the entry day's extreme by a volatility distance and then moves with subsequent highs or lows to keep remaining risk bounded.
The first stop after entry
Daily noise is treated as the high-to-low range. Average daily volatility is the mean of that range over the most recent half of the dominant cycle, and it supplies the market-adaptive distance for the first stop after entry.
For a long, that average is subtracted from the entry day's low to set the next day's stop. For a short, it is added to the entry day's high.
The initial offset may be a multiple of average daily volatility, commonly between one and two.
Why the entry day has no stop
The construction omits a stop on the entry day because the position may not yet exist and because the volatility offset often requires an extreme move to trigger.
Age schedule to the half-cycle horizon
The dominant cycle is the short-term price cycle whose length supplies both the half-cycle lookback for the initial offset and the age at which the remaining stop gap is fully removed. Once that length is known, the intended hold is half that cycle, the half-cycle horizon from valley to peak or peak to valley.
Stop acceleration is scheduled from trade age so the remaining gap is fully removed when age equals that half-cycle. The acceleration factor is the age-based fraction of the remaining extreme-to-stop gap that is removed when computing the next day's stop.
The next long stop equals the prior stop plus twice the trade age divided by the dominant-cycle length, multiplied by that day's low-to-stop gap. Squaring the age ratio is noted as adding little practical benefit.
Matching the schedule to the observed cycle
Cycle length can be counted from swing to swing or measured with maximum entropy spectrum analysis so the trailing-stop age schedule matches the observed dominant cycle. Maximum entropy spectrum analysis is a spectral measurement of ordered price observations used to estimate that cycle length instead of assuming a fixed period.
When a measured cycle is unavailable, a fixed 20-day cycle can be used as a conservative nominal length.
All readings on this track · 28 readings
- 1984Constructing maximum-entropy spectra for dominant-cycle forecasts
- 1984How to construct a maximum-entropy cycle model
- 1984Constructing a maximum-entropy forecast from a chosen lookback
- 1985Constructing period-locked half-cycle and full-cycle averages
- 1986Why Fourier windows limit dominant-cycle resolution
- 1987Assembling short-lookback maximum-entropy cycle forecasts
- 1988Why a fitted dominant cycle is not a forecast
- 1989Evaluating commodity cycle personalities with spectral histograms
- 1989Evaluating next-session cycle forecasts with stops
- 1989Constructing cycle-aged volatility trailing stops
- 1990A channel signal-to-noise gate for dominant-cycle forecasts
- 1990Year-over-year dominant cycle personality audit
- 1991Cyclic entry from a locked dominant-cycle phase
- 1992Stationarity states on synchronized futures spectral contours
- 1997Hidden horizon assumptions in dominant-cycle readings
- 1997When market cycles are absent more than present
- 1997A spectral estimator that retunes indicators to the measured cycle
- 2000Constructing a Hilbert dominant cycle and a maximum-entropy refinement
- 2000Switch trend and cycle indicators after a half-cycle dwell test
- 2000Constructing a dominant-cycle squelch trend filter
- 2000Phasor displays for dominant-cycle construction
- 2002Low-lag trendline from elliptic and dominant-cycle notches
- 2004Spectral peaks are mode diagnostics, not forecasts
- 2004Compressive last-stage oscillator construction
- 2013Constructing trend failure curves from qualified-trend transitions
- 2014Lookback range, a two-lag smoother, and next-bar fills
- 2014Constructing a MESA stochastic with roofing and SuperSmoother filters
- 2016Constructing spectral heatmaps for dominant market cycles