As the name implies, this filter serves as a stop-loss to exit your position (as a Sell Filter if long, or a Cover Filter if short).
It will exit a long position whose closing price drops below a certain distance (line). For a short position, the closing price must break above such a line. This line is plotted by: measuring the instrument's ATR (for a certain period), which is then multiplied by a certain number. This multiplied ATR is then subtracted from the closing price of the previous day (or added, for a short position). Note, the ATR value also comes from the previous day.
In other words, if today's closing price violated such a line (which is based from yesterday's ATR and closing price), the position will be liquidated tomorrow. As shown in the illustration below, the line is colored blue:
Thus, it's a flexible stop-loss that may go up or down, based on the instrument's closing price and volatility; unlike the Perfect Stop Filter where the stop-loss line is trailing continually upward (or downward, for a short position). On one hand, this dynamic behavior may actually expose you to greater losses if the downtrend is slow. On the other hand, it prevents your from getting stopped too early, so you ride your position along unless there's a big one-day drop.
1. The first parameter defines the ATR multiplier:
The sweet spot is usually 2.5 or 3. So for example, if the price drops greater than 2.5 times the volatility of the past 10 days, it's a good sign of a trend change. Clearly, a bigger value here means a wider stop-loss.
2. The second parameter defines the ATR period:
For example, “10 days” means the average price change of the past 10 days (in dollar value). Generally, use a shorter period less than 1 month here (10 or 14 days is the sweet spot) so the volatility is representative of the recent price behavior. Longer period may be useful for long-term trading (might as well invest); remember that Portfolio Boss is mainly swing trading based on the daily candles.
The visual indicator is plotted alongside the price chart (on the Instrument Tab). For a long position, it appears below the prices:
For a short position, it shows up over the prices: