Trailing Stop Loss using Parabolic SAR and other technical analysis approaches are often misleading. This will keep you out of trouble!
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Welcome, my friend to this video on Parabolic SAR, which stands for Parabolic, Stop and Reverse. It is a time price system, and it’s a very cool technique. The developer is Welles Wilder, a very famous name in technical analysis. He wrote the book, ‘New Concepts in Technical Trading Systems’, back in 1978. One of the most famous books ever written in technical analysis, and it is indeed an excellent book. I want to point out a few things that you better be careful of, and here they are. (See video)
Trailing Stop Loss
When the indicator’s blue dots are above price, you’re looking to go short. When they’re below price, you’re looking to go long. It’s a type of trailing stop when the dots go from below price, to above price bars, that’s when you would stop and reverse. This kind of thing works fantastic with trends! The longer the trend continues, it has a step to it in the formula which tightens up that stop the longer it goes. Which is why time is involved as well. I can point it out to you real quick in the video.
See how far away it is from the bar here, and how close it is to the bar there? It’s a nice situation with the mathematics of it where it gets tighter as time goes on. The idea is, if the market stops trending, you don’t lose as much. In this situation – and this is part of the deal – it did not keep you in for the full trend. The market continued going down. Even though we have this big, long move, Parabolic SAR would have stopped us out in the middle of the move.
(You can see how to change the parameters in this video.)
Trailing Stop Loss-For Day Traders
If you’re gonna day trade and use the parabolic SAR, you gotta be careful at the open. When you get something like this, (see video) where you get a gap from one day to the next, this vertical line. That’s the end of one day, and the beginning of the next day. It’s really still measuring the close of yesterday, but we gapped down here, and this is still telling us to go short, based on these bars.
It’s a 14 period parabolic SAR, so it’s going to be lagging there, and that’s why it doesn’t switch until here. If you shorted this you’d be in a world of pain. The idea of this thing giving you tight stops, does not work very well when you get a gap at the beginning. That is not a tight stop, you’d be going short here, and the market comes up against you quite a bit. Not good.
When markets don’t trend, this thing doesn’t work so well, and neither do any other indicators that depend on trend.
Trailing Stop Loss-Past and Present
When Wells Wilder wrote the book, ‘New Concepts in Technical Trading Systems’, he estimated the markets trend 30% of the time, so he created a lot of great, very famous indicators. The RSI, Average True Range, ADX this one, and it was about trending markets, which is fantastic, but yes, he was right. Markets did trend more back then. That book was written in 1978, which was pre-computer age. That was a year after I graduated high school, for goodness sake! I certainly didn’t have a computer. I didn’t get a computer until graduate school, and even then we didn’t have internet.
What he was teaching was great for that time, but the markets move differently now. Everybody and his pet hamster has direct access to the markets, and commissions are really cheap, so you can get in and out fast inexpensively. When I first started trading it was like $50 to get in, and $50 to get out, so it didn’t pay to get in and out of the market in a couple minutes. You couldn’t do it because you didn’t have access to the data. Now everybody has real time data, direct access, cheap commissions, people are getting in and out fast. They move differently now.
Trailing Stop Loss in Today’s Market
You’ve got to have a different approach to trading. You’ve got to have targets and not just use trailing stops. You’ve got to be able to get in, and out quick when the markets not trending, and still hit singles. Instead of going for home runs all the time, 9 out of 10 of your trades are gonna be just singles. just a little single. (A little baseball analogy there.)
Many people ask me: “How do you know if the trends gonna follow through?” I don’t know the future, and neither do you. God does but he’s not telling me, so what do I have to do? I have to watch the market literally bar by bar because that’s how the market is today.
Past performance is not indicative of future results.
What the market used to do, or what it’s done over the last thirty days, means diddly-squat, because things happen so fast today. It’s a global marketplace now. You have people from all over the world, not just the United States, not just the UK, but all over the world trading these things. Not everybody is in sync with everybody else, and that creates chaos.
Final Thoughts
When I was in Chicago, they would say, “A scratch is a win!” What they meant by a ‘scratch’ is, just a break-even trade. Every trade that has your probability scenario in it, or your mathematical statistical model, take every one of them. Then you place your stops really close. For me and my methodology, I would never place a stop far away. I never risk the range of more than a bar, to a bar and a half. I’m not going to risk that much money on a single trade.
Now more than ever, you have to become a master of risk management in money management. Don’t expect to get the big home runs all the time. When I day trade, I would say on average out of five days, I’m gonna get two huge winners. Those winners can be a whole month’s worth of income, so yes, it’s worth it. You gotta be there for each trade, so when the big winner comes, you’re there.
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