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Chapter 29 · Volatility Indicators

ATR in practice: stops, sizing and the squeeze

Turning volatility into a stop distance, a position size and a warning that a quiet stock is about to move.

52 of 66 · 12 min

NEPSE's daily circuit limits put a ceiling on ATR: a share locked at its band cannot travel further, so its measured volatility is lower than its real volatility and any stop sized from that number is tighter than you think. Read the method below with that correction in mind.

Why a stop should be sized in ATR

Rs 5 stop2 × ATR stopthis stock travels about Rs 12 on an ordinary daythe red stop sits inside the daily range and is hit four timesthe green one sits outside it and is never touched
A stop placed inside the stock's ordinary daily range gets hit by noise, not by being wrong. ATR puts the stop outside that range.

ATR is the most directly useful indicator in this course, because it converts a guess into a measurement. A stop is a distance, and ATR is what tells you whether your distance is inside or outside the stock's ordinary behaviour.

The chain, from volatility to position size

  1. 1Measure ATR — how far the stock ordinarily travels in a session.
  2. 2Set the stop at a multiple of ATR beyond your invalidation level, so noise alone cannot reach it.
  3. 3Divide the rupees you are willing to lose by the stop distance. That is the position size.
  4. 4The size falls out of the volatility. It is not a judgement about how much you like the idea.

Worked: two stocks, the same risk, very different sizes

Portfolio Rs 10,00,000, risking 1% — Rs 10,000 — on each.

Stock AStock B
PriceRs 428Rs 428
ATR(14)Rs 12Rs 5
Stop at 2 × ATRRs 24 → stop 404Rs 10 → stop 418
Shares = 10,000 ÷ stop4161,000
Capital deployedRs 1,78,048Rs 4,28,000
  • Same price, same rupee risk, 2.4× the position in the quieter stock.
  • This is correct: the quieter stock has to move further, in its own terms, to cost you the same money.
  • Sizing every position at 'about 10% of the portfolio' ignores this entirely and makes the volatile holding the one that decides your year.

Choosing the multiple

MultipleEffectSuits
1 × ATRTight; stopped out often by ordinary movementRarely appropriate
2 × ATROutside most single-session noiseThe common default
3 × ATRSurvives most pullbacks; needs a smaller positionTrend following
Chandelier: highest high − 3 × ATRTrails upward only, never loosensRiding a trend

Bollinger Bands and the squeeze

squeezevolatility at a lowexpansionupper and lower = 20-SMA ± (2 × standard deviation)middle band = 20-SMA
The bands are two standard deviations either side of a 20-period average. They narrow when the stock goes quiet, and quiet does not last.

The squeeze

Bandwidth = (upper − lower) ÷ middle. At a multi-month low, the stock has gone unusually quiet — and quiet does not last. The squeeze says a large move is more likely than usual; it says nothing about direction, which must come from somewhere else.

Worked: SMA(20) = Rs 420, standard deviation Rs 8. Upper 436, lower 404, bandwidth = 32 ÷ 420 = 7.6%. If that has typically been 14%, volatility is at half its usual level.

Turn an ATR stop into a position size→

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