The New Sell and Sell Short: How to Take Profits, Cut Losses, and Benefit from Price Declines, Expanded Second Edition

A SAFEZONE STOP

SafeZone stops are based on the concept of signal and noise in the financial markets. If the price trend is the signal, then the counter-trend moves are the noise. Engineers build filters to suppress noise and allow the signals to come through. If we can identify and measure market noise, we can place our stops outside of the noise level. This allows us to stay in the trade for as long as the signal identifies a trend. This concept was described in detail in Come into My Trading Room and has since been implemented in several trading programs.⁶

Figure 5.16 DE daily, SafeZone

Trend-following systems shine during powerful trends but lead to whipsaws in trendless markets. You can see how SafeZone caught a powerful upmove in DE in the middle of the chart. This is where a trailing stop performed at its best. In the relatively trendless zones near the left and right edges, a trend-following method delivered multiple whipsaws. This chart sends a clear message—use trailing stops only during powerful trends.

We can define a trend in a variety of ways, including something as simple and straightforward as the slope of a 22-day EMA. When the trend is up, we define noise as that part of each day’s range that protrudes below the previous day’s low, going against the trend. When the trend is down, we define noise as that part of each day’s range that protrudes above the ...