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I am wondering if there is a rule-of-thumb for setting a trailing stop (fixed percent) if you know the annualized volatity. I calculate volatility from daily close price using the simple returns, $r_t = (P_t - P_{t-1})/P_{t-1}$, then get the s.d. $\sigma$ of the returns $r_t$, and annualize via $\sigma \sqrt{252}$. So if I rebalance e.g. monthly (every 20 trading days), is $\sigma \sqrt{20}$ a resonable estimate of the stop loss?

Thinking about a 20-day volatility, however, it would represent the expected total variation of jumpyness over the 20-day time series, so the trailing stop would need to be a fraction(multiple) of the total. Hence, my gut feeling for the existence of a general rule-of-thumb. Would "2-sigma from the mean" be an appropriate assumption, where $2\sigma \sqrt{20}$ is used?

UPDATE

Based on looking at charts of SPY, MRNA, AYI, RBLX, AYI, etc, with a trailing stop indicator with fixed percent, it is looking like $\sigma\sqrt{20}$ is almost perfect.

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  • $\begingroup$ Yes, what you say is reasonable. $\endgroup$
    – noob2
    Oct 15 at 12:31

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