Last week, we took a look at how you can accidentally hurt yourself when you mismatch a high-volatility stock with a stop loss. This week, we’ll discuss an easy way to keep you out of that kind of trouble.

Very volatile stocks aren’t just likely to trip your stop losses—if you even use stop losses—they also tend to look like they’re about to drop dead a few times a year. You see this, you sell the stock, and then the next week it’s back setting new highs and you’re groaning. So now, let’s look at how to measure volatility.

If volatility is simply a lot of movement, does that mean a lot of dollar points up and down each day? A large percentage of its stock price each day? Or, a lot compared to an index?

All those possibilities contribute something to the story. But the most intuitive place to start is with how much a stock goes up and down in price. We would accept gigantic moves to the upside, of course. But how much movement the wrong way are we courting to get that? Is the stock likely to gain or drop $5 in a single day on a regular basis, or only 75 cents in a normal swing?

There is a very simple way to check this. It’s free. If you have a computer, you can get the facts at Stockcharts.com easily. Another free source is Incrediblecharts.com. The tool you want is called “average true range,” or ATR. Let’s take a look:

Here’s a nice little biotech that is well established, Gilead Biosciences. On this chart, the ATR for Gilead was about $1.30 a day last November and $1.70 in March.

If all you want to know is how volatile your stock is, you can stop right here. You now have a tool you can use. Vaya con dios and prosper. If you want to learn a little more about where ATR comes from and what else it can predict, read on…

Gilead is a pretty busy stock, but even so, it’s not often that it moves up twice its ATR or more within two days. It’s even more rare for it to fall that much in two back-to-back days. Now that you’ve seen your first chart. Let’s look at ATR itself a little more closely.

The ATR is calculated over a set period. Usually, it’s a 14-day average of the true range. A “true range” is not a complicated statistic. It is simply how much a stock changes in a day. So it can be calculated as-

• Today’s high minus today’s low (that is, the whole range for today)
• Today’s high minus yesterday’s close (how much it went up since yesterday, if that’s more than today’s range)
• Or today’s low subtracted from yesterday’s close (how much it went down since yesterday if the stock is falling).

You don’t have to struggle with remembering that now that you have an idea what a true range is. It’s just today’s high to low, or the amount it went up or down since yesterday, if that’s a bigger number. Chart software will do all the calculating for you, anyway, but you know enough so this tool is not mysterious anymore. That’s all that’s necessary.

I began looking at ATRs years ago when trying to figure out whether a stock was likely to move enough in the short run to make an option pay off. From looking at hundreds of charts over the years, I developed a seat-of-the-pants notion that two times the ATR was a significant number I could use.

Even on a biotech stock, and much more so with blue chips, it is quite rare for a stock to move its full, current ATR range one day then continue in the same direction for an additional full ATR move the next day. And doing it with no backtracking or overlapping in price for three or four days is exceedingly rare.

It seems that two back-to-back full-ATR moves down (or three up) is about all you can expect from the stock’s normal behavior. After that, the stock usually reverses course or stands still for a while.

This then gives you an idea of what kind of sudden wrong-way movement you might have to put up if you buy a particular stock.

My two-times-ATR rule is just a rule of thumb I developed as one of my personal shortcuts. It has no textbook blessing that I know of. But it seems to have a bit of a pedigree after all.