Volatility: the stock's own units

After this lesson you can measure how much a stock normally moves, and you'll set every stop in the stock's own units instead of round numbers.

Every stock has a stride

Some stocks travel 1% on a normal day; others travel 6%. Before you can call any move "big" or place any stop sensibly, you need the stock's own baseline, and there are two standard rulers.

ADR — average daily range. Take each day's range (high minus low) as a percentage of price, average it over the last few weeks. A stock with a 2% ADR that's up 1.8% today had an ordinary day. A stock with a 1% ADR up 1.8% just did something unusual. The headline number is identical in both cases, and the ADR is what tells them apart.

ATR — average true range (J. Welles Wilder's construction, from 1978). The same idea in currency units rather than percent, with a technical wrinkle: each day's "true range" extends to cover any gap from the prior close, so overnight jumps count. If a €50 stock has an ATR of €1.50, its normal daily travel is about €1.50.

Stops in the stock's own units

Here is where School II and this school fuse. A stop 2% away sounds reasonable in the abstract. On a stock with a 4% ADR it sits inside one ordinary day's wobble. Ordinary noise will reach it, and you'll be stopped out of trades that were never wrong. On a stock with a 1% ADR the same 2% is two full days of travel, a properly meaningful distance.

So the craft rule: a stop must clear both the level where the idea fails (course 3) and the noise the stock generates around any level. In practice you take the technical level and give it breathing room measured in ATR, and a fraction of an ATR beyond the level is a common convention. Then School II's division sizes the position. A wilder stock needs a wider stop, and the wider stop returns a smaller share count without you having to decide anything. Volatile stocks stay tradable; the division just hands you fewer shares of them.

Contraction and expansion

Volatility runs in cycles. Long quiet stretches tend to end in big moves, and after a big move the stock usually settles down again. The useful part for a trader is the quiet side. Late in a good base (course 3), each successive pullback tends to get shallower (first 15%, then 8%, then 4%) while volume dries up (course 4). The stock is contracting: supply is exhausting and the range is tightening.

Mark Minervini named this signature the Volatility Contraction Pattern (VCP) and made it central to his method: the contraction is the setup, and the expansion out of it (the breakout, on returning volume) is the event. The logic assembles everything this school has taught so far: a base (structure), contracting range (volatility), drying then returning volume (participation), resolving into a Stage 2 leg (trend). School V builds entries on exactly this assembly.

Check yourself

1. Stock A has a 1.2% ADR, stock B 5%. Both fall 2.5% today. Which one did something notable? (A — that's more than two of its normal days. For B it's half an ordinary day.)
2. R = €100, entry €40, technical level €38.60, ATR €1.20. Why might €38.50 be a poor stop, and what's the fix? (It sits barely beyond the level, well inside one ATR of noise. Give it a buffer — e.g., €38.00 — and let the division shrink the share count to keep the cost at 1R.)
3. What is a volatility contraction late in a base telling you? (Supply is drying up: the pullbacks get shallower and the volume gets quieter. The range tightens ahead of the expansion.)

The idea this lesson installs

Measure every stop in the stock's own daily travel.

Next: Course 7 — "Gaps on the chart."