In our last lesson we learned about the Average Directional Index (ADX) an indicator which helps traders determine the strength of trends in the market. In today’s lesson we are going to look at another indicator called the Parabolic Stop and Reversal (Parabolic SAR), which helps traders enter and manage positions when trading those trends.

The Parabolic SAR is an indicator that, like Bollinger Bands is plotted on price, the general idea of which is to buy into up trends when the indicator is below price, and sell into down trends when the indicator is above price. Once traders are in positions the indicator also assists in managing the position by providing guidance as to how one should trail their stop.

Example of the Parabolic SAR



While this is an indicator that works very well in trending markets, as you can see from the below chart simply following the basic be long when the indicator is below price and be short when the indicator is above price will lead to many whipsaws in range bound markets.

Example of Whipsaws in Range Bound Markets


To combat this problem the developer of the indicator J. Welles Wilder (who also developed the RSI and ADX) recommended establishing the strength and direction of the trend first through the use of things such as the ADX, and then using the Parabolic SAR to trade that trend. As mentioned above although the Parabolic SAR is used for both entering and managing positions, it is used far more to set stops once in a position.

As with the other indicators we have covered in past lessons it is recommended to use this indicator in conjunction with other methods of analysis for confirmation not only on trade entry but also on trade exit.

Example:


That’s our lesson for today. While my lessons are by no means exhaustive on the subject this also concludes my series on technical indicators. If you are interested in learning more about the indicators that we have studies as well as some of the other indicators that traders use, I encourage you to visit the technical indicators section of informedtrades.com.

In our next lesson we will begin a new series by taking a deeper look at candlestick chart patterns and how one can use these in their trading.

As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!

Hi,

Thank you for posting these videos on Technical Analysis. Your videos gave me a better understanding of Technical Analysis.

I have been subscribing to a charting service for the last three months and have been viewing charts with different indicators. The strategies you described followed by traders for entries and exits for different chart patterns and technical indicators gave me a better perspective of charting. Previously I used to just look at the chart patterns as some lines drawn with specific shapes and now it's defenitely making a whole lot more sense to me.

Again, thank you for your time and effort in making these awesome videos.

Sincerely,

newbietrader

Hi Newbietrader,

Thanks for the feedback I am glad you like the videos. There are more to come so let me know if there are any that you would like to see done.

Best Regards,
David

i used to trade based on on chart patterns and volume. your videos on indicators are very useful in helping me with my trades. thanks again.

Hi Dave:

Will you please do a chapter on volume and how to interpret it in up and down trending markets.

Also, will you please clarify how do you ascertain buying pressure and selling pressure from volume. Because, per me every selling involves another person buying the security so how do the selling and buying imbalances come into play?

Many thanks for all your work in getting this across to us.

M

Hi Maajoba,

Glad to hear from you.

Below is a lesson which covers how volume should follow trend:

Technical Analysis Lesson 3 - The Last 3 Tenets of Dow Theory

You are correct that for every buyer there has to be a seller which is why rising volume by itself does not tell you anything, but when combined with trend analysis can be valuable.

When the market is in an uptrend this indicates that at lower prices there were more people seeking to buy than sell so the market had to rise in order to offset the imbalance between buyers and sellers.

Conversely when the market is in a downtrend this indicates that at higher prices there were more people looking to sell than buy so prices had to fall in order to offset the imbalance between sellers and buyers.

When these two scenarios are accompanies by rising volume this means that there is a lot of participation in the move which generally means that it has a greater chance of continuing than it otherwise would have.

Let me know if that is not what you are looking for.

Best Regards,
Dave

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Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.