When to Stop Trading

Category: Articles

This article written by Brett N. Steenbarger

Much of the advice given to traders concerns either what to buy or sell or when to buy or sell. This makes sense, as it is doubtful that brokerage houses and advisory services could make much of a living by telling traders not to trade. My experience with professional traders, however, suggests to me that they frequently wrestle with the question of when to stop trading. This question typically emerges in two contexts:

1. The volatility in the market is low - Does it make sense to be in the market? Is there sufficient opportunity?

2. I’m not trading well - Does it make sense for me to continue trading? Do I need to take a break?

In the first installment of this three article series, I will tackle the issue of low volatility; the second in the series will cover challenges related to trader psychology, and the third will suggest ways for traders to benefit from their times away from trading.

In a previous Trading Markets article, I presented statistical evidence that suggested a serial correlation between forty day periods of volatility.
Going back to the 1960s in the S&P 500, I found that the correlation between the volatility of the current forty days and the volatility of the next forty days has been over .70. This means that you can accurately predict over half of the future variation in volatility simply by knowing past volatility. I have observed similar serial correlations of volatility at other time frames, including intraday.

Here we are measuring volatility as the standard deviation of price changes for a given period. This means that, in a high volatility market, we would see large variability in average price change: some days would have large winners and large losers, others would have smaller changes. In a low volatility market, we’d experience low price change variability. The size of price changes would tend to cluster relatively near the mean for that historical period. Because of this, volatility is one measure that we can use to determine the movement that we are likely to see during our trading time frame; it is a measure of expectable opportunity.

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