The Curious Investor

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After a small digression into lower indicators yesterday, we’re returning to the upper indicators, or indicators which are graphed on the price chart, today. This is the last of the available indicators on bigcharts.com and, hopefully after reading this part of the series, you’ll have at least a good idea of the information that each of these upper indicators gives you about a stock’s price and the way its trading. On Friday, I’ll be putting it all together in a simple analysis system that puts together some of these indicators and that you’ll be able to use right away to start making better stock picks and to better time your buys and sells.

Today’s indicator is the Parabolic SAR (seen above). This indicator was created by J. Welles Wilder, a famous market analyst who revolutionized technical analysis. It was his mathematical analysis in the 1970s which is responsible for many of the indicators that investors still use today. Parabolic SAR is a statistic that he developed which uses a complex mathematical formula to derive stop-loss points for a stock during a trending period. The exact nature of the formula is complex and difficult to find, but a good explanation of how the system works and the logic behind the formula can be found here. Basically, it is a calculation based on when a stock makes a new high and low and an acceleration factor which brings the Parabolic SAR points closer to the real price of the stock as a trend ages. On bigcharts.com, the graph of Parabolic SAR is connected into what looks like parabolic curves, but many other charting sites will simply use dots for each day.

A buy-point is signaled when the Parabolic SARcurves under the price “curve” and a sell point is signaled when the Parabolic SAR touches the price curve or switches above it. Essentially, the Parabolic SAR curve, while it is under the price curve, serves as a moving stop-loss line. Should the price drop below the Parabolic SAR, you know to sell it. If you are selling short, then you can think of this in reverse. Cover if the price of the stock ever reaches above the Parabolic SAR.

As you can see from the above graph, the Parabolic SAR can fluctuate quite a bit creating many buy and sell signals. One of the main disadvantages of Parabolic SAR is that it is a very sensitive statistic which makes it nearly useless when there is not an established trend. For example, between the months of May and September, you will see 5 buy and 5 sell points and if you had bought and sold with every signal you would not have made any money what so ever. As such, Parabolic SAR is not necessarily a very good signalling indicator for buying though it is a good (if not relatively conservative) indicator for sells especially if it is to protect gains. Take a look at the graph below.

As you can see from this graph, there has been a prolonged uptrend since early-to-mid september. Parabolic SAR had one false alarm at the end of October but has essentially been confirming that this uptrend is strong by maintaining itself well below the stock price. Now, at the end of November, we see Parabolic SAR starting to catch stock price and it is important to watch this stock carefully as the uptrend may be running out of steam. In the case here, Parabolic SAR has been much more meaningful than the first graph in this article.

As you can see from the two very different graphs, Parabolic SAR is a quintessential example of why we should not trust all our stock picks to one indicator. Different indicators are effective in predicting different kinds of stock movement and it is necessary to make sure evaluate a stock from multiple perspectives before making a decision on buying or selling. For me, I rarely use Parabolic SAR to signal buys. Instead, it serves as confirmation of a perceived buy point (established through use of Price Channel or MACD) and then it serves as my stop-loss barrier and is one of my most important variables as far as deciding when to sell to take profits.

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