THE PARABOLIC STOP AND REVERSAL (SAR) SYSTEM WORKS WELL IN FAST RISING MARKET LIKE GOLD -- FILTERING DAILY SIGNALS WITH WEEKLY AND MONTHLY CHARTS -- STAGGERING SELL STOPS
USING SAR IN FAST RISING MARKET ... Different market conditions require different indicators. Fortunately, Stockcharts offers a wide variety. What works in a trading range market doesn't work as well in a trending market. What works in a market that's trending gradually higher might not be suitable for a fast-rising market. Back in February, I wrote a series of articles on how to apply the Parabolic Stop and Reversal (SAR) system to the gold market (February 03, 2006). Given the steep rise in the price of gold, I thought this would be an opportune time to revisit the SAR. It's a trend-following system that works especially well in a fast-rising market like gold. It keeps you in the market while it's rising, but doesn't give back as much when it enters a downside correction. Chart 1 shows the Parabolic SAR applied to the StreetTracks Gold Trust Shares (GLD). The SAR dots are protective buy and sell stops. In a rising market (like right now), the sell stops are placed below the price bars. In a falling or flat market, buy stops appear above the price action. That was the case for most of February and March when the market entered a consolidation phase. A buy signal is generated when a buy stop is hit. The last buy signal took place on March 24 (last green circle)and has been in effect for twenty-seven trading days. To give a short-term sell signal, the GLD would have to hit the last dot (at 63.38 and rising). Chart 1 shows six trading signals (see circles). I'm not suggesting that a trader would follow each signal. There are some guidelines.
Chart 1
GUIDELINES FOR DAILY SIGNALS... The Stop and Reversal (SAR) name suggests that a trader who gets stopped out of a buy position actually reverse to the short side. I'm not suggesting that. In a rising market, I recommend using daily SAR sell stops for partial profit-taking. As long as the major trend is up, however, I would avoid the short side. [More on that later]. We use sell stops for short-term profit-taking in a rising market. We use buy stops to restore those long positions. If you study Chart 1 more closely, you'll see that the SAR gets you in and out of uptrends early. It's a sensitive indicator. In a trading range (like February and March) it doesn't work as well. It will get chopped around in a sideways market. Once the uptrend resumes, however, it gets you in back in, keeps you in, and then gets you out pretty close to the top. What makes the SAR so helpful in a fast rising market is that it hugs the price trend closely. It has a built-in acceleration factor that gives it a parabolic look (hence its name). The SAR rises faster than a moving average which tends to rise with more of a lag. But how do we avoid short-term whipsaws when the trend turns sideways. We do that by filtering the daily SAR signals with weekly signals.
USING WEEKLY PARABOLIC SIGNALS ... As is the case with most technical indicators, we filter daily signals with weekly signals. Chart 2 applies Parabolic SARs to a weekly chart of the GLD for the last six months. Naturally there are fewer signals. The green and red circles show three intermediate-term signals since last November. The SAR was on a buy signal in 19 of the last 25 weeks. When prices are over the SAR (as is the case now) the intermediate trend is up. Notice that a sell signal was given during the second week of February and lasted for six weeks. It was during that six weeks that the daily charts got whipsawed several times. In that case, it's best to sit on the sidelines until a weekly buy stop is hit. That happened during the week of March 27. It's been uphill ever since. That's how we use weekly signals to filter daily signals. Buy signals on the daily charts work better when the weekly signals are in an uptrend. When the weekly signals are negative, it's better to wait. How do we filter weekly signals? With monthly charts.
Chart 2
USING MONTHLY PARABOLIC SIGNALS ... Parabolic SAR signals on the monthly chart tell us the major trend of a market. Chart 3 applies SARs to the monthly chart of the gold ETF. Since giving a buy signal in October 2004, the monthly SAR has been in an uptrend for the last twenty months. The GLD has to hit the last SAR (now at 53.15) to give a major sell signal. Here's how I recommend combining the three time dimensions. When the monthly trend is up, follow only buy signals on the weekly charts. If the weekly trend is up, follow only buy signals on the daily charts. If a longer-range chart is negative, hold off on further signals until all three are in agreement. No indicator is perfect and that's certainly the case with the Parabolic SAR. Nor should any indicator be used all by itself. In a fast rising market like gold, however, it's one of the best one's around.
Chart 3
STAGGERING SELL STOPS ... In one of my February articles, I distinguished between short-term trading positions and long-term core positions in the gold market. In other words, use short-term sell signals on daily charts to take profits on only the trading portion of your holdings. That might be only a third of those holdings. Hold onto the rest. A weekly sell signal might justify taking profits on another third. A monthly sell signal is needed to consider leaving the market entirely. Using that approach, you can take some money off the table when a market is too overextended, or if the short-term is weakening, while still holding onto your long-term core position. That's the strategy I've been using throughout the major bull market in commodities and their related stocks. [Editors's Note: All of the indicators that I use are available to Stockchart users. Parabolic SAR can be found on the Overlay menu. Two others that I showed on Friday -- Bollinger Band Width and %B -- are listed on the Indicator menu. If you don't see them, scroll down until you do. More information on all indicators can be found in the Stockcharts Chart School].
