The Art & Science of Technical Analysis by Adam Grimes

Author:Adam Grimes
Language: eng
Format: epub
ISBN: 9781118238141
Publisher: Wiley
Published: 2012-05-21T16:00:00+00:00

Though it is difficult to trade the Parabolic as a stand-alone system in the always-in context that was originally intended, it can be an extremely useful tool for discretionary traders who can turn to the Parabolic for trailing stop levels in trending markets. It is possible to initiate a position, take your first partial profit (if that is in your trading plan), and then use the Parabolic’s levels as trailing stops. When the stop level is hit, exit the position but do not flip. The usual caveat applies: it is a mistake to use any trading tool that you do not completely understand. If you are going to use the Parabolic, do whatever you need to internalize its calculations. If calculating it by hand or in a spreadsheet helps, do so. I would highly recommend some kind of test environment where you can apply it to artificial data series you create (see Chapter 7) so that you can see how it reacts to every imaginable market situation.

A similar idea is found in Chuck LeBeau’s chandelier stop, which basically hangs a stop a fixed number of ATRs from the extreme point of a trend, creating a stop level that is comceptually similar to the Parabolic without the acceleration factor. One of the problems with using the Parabolic on a strict, systematic basis is that the acceleration factor is constantly moving the stop closer to the market, even when there is no trend at all. While this is desirable behavior in some contexts, it also results in multiple flips from long to short while the market is chopping sideways. The chandelier exit usually gives the trade more room, which, though it may result in larger losses, will also allow you to stay in trades at the beginning of trends. Conversely, in mature trends the Parabolic will usually tighten stops dramatically compared to the chandelier stop, which may help to protect profits in open trades.

Other Price Action/Market Structure Stops

It is also possible to use references to price action and market structure for trailing stop points. For instance, a simple plan might be to stop out of an uptrending market on the first down close, at the lowest low of three days ago, or on two consecutive downward closes. If you are going to explore these, also consider stops that limit your loss on any one day, perhaps stopping out a certain ATR multiple from the previous day’s high, low, or closing values, and be certain that you understand the statistical tendencies supporting your stop plan. For instance, all other things being equal, stopping out after three consecutive downward closes in stocks would be a bad plan because the market is usually primed for a bounce at that point. Whatever you choose to do, it should be subjected to a battery of statistical tests if possible, and backtested by hand (so that you see each detail of each trade) on at least several hundred trades.

Any of these stops will work well in strongly trending

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