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Parabolic

The parabolic method is based on a mathematical formula derived from the parabolic curve. It provides the trader with two values each day: a sell number and a buy number. These serve as sell stops and buy stops.

Penetration of the buy number means to go long and close out the short, while penetration of the sell number means to close out longs and go short. I have included an example of a parabolic indicator plotted on a intraday price chart in Fig. 2-5.

The Good News. The parabolic indicator is totally objective. It can be used as a mechanical trading system with risk management methods. In addition, it provides a buy and sell stop and is therefore capable of changing orientation from long to short very quickly.

The Bad News. This method can get "whipsawed" badly in sideways or highly volatile markets (note Figure 2-5). The parabolic method can catch some very large moves; however, it has many of the same limitations that are inherent in the use of traditional moving averages.

Solutions. Use parabolic with other indicators that are not necessarily based on price, i.e., volume and/or open interest. Use shorter-term time frames for exiting parabolic trades. Also, since parabolic, in its pure form, is an "always in the market "system, you may be able to adapt it by specifying certain conditions in which it goes into a neutral stance (i.e., no position).

ADX and DMI

ADX and DMI are unique indicators based on reasonably solid theories about market movement. They are calculated with relative ease and may be used either objectively as part of a trading system or as trend and market strength indicators. (See Figures 2-6 and 2-7.)

The Good News. These methods are not based on effete concepts or market myths. They are well worth investigating for development into trading systems.

The Bad News. They tend to lag somewhat behind market tops and bottoms. As a result, they can give late signals that will cost you money.

Solutions. Use these indicators in conjunction with other indicators that are based on different theoretical understandings of the markets. The DMI difference is the indicator I recommend for DMI work.

Use a derivative of the DMI or ADX as part of your method. In other words, compute a moving average of the ADX or the DMI and use the moving average to develop more accurate timing.