Parabolic SAR Strategy

I'm not entirely satisfied with the way the price-channel breakout strategy performs when applied to forex trading. See my "How I Trade" guide for a complete description of the strategy.

The problem is, currencies have a strong tendency to revert to the mean, and a lot of big banks and governments have a vested interest in seeing that they do just that.

So, under those circumstances, a breakout often represents the end of the road for a trend rather than a new beginning.

Also, most of the high-margin forex pairs, under U.S. regulations, trade at fairly low average direction index (ADX) readings, certainly below the 25 minimum that my price-channel strategy demands.

For forex (and also for exchange-traded funds) I've routinely ignored the ADX component of the strategy, but for a private trader, rule-breaking is like a gateway drug: Ignore a rule here and ignore a rule there, and pretty soon you're tossing money to the winds like a profligate child paradoxically convinced in your heart of hearts that you are invulnerable, and that there is no tomorrow.

So, what's a private trader to do? Innovate, of course.

I'll be trying out the following very simple strategy on forex and exchange-traded fund plays over the next six weeks. It resembles the price-channel strategy only in that it requires me to crawl tortoise like into a positions and to jackrabbit out in a flash.

I'll apply the strategy on a daily chart showing the price open, high, low and close, with the parabolic sar with a 0.02 acceleration factor and a 0.2 acceleration limit (which is standard), and with the 14-day average true range (ATR) for stop-setting.

That's it. No ADX, no need for volume even, no macd or other indicators.

Now, up front, a strategy like this will be prone to the false signals and whipsawing that makes the parabolic sar famous.

However, my experience has been that the price-channel breakout strategy also has a high number of false signals -- a breakout followed by an immediate reversal.

The parabolic sar strategy, by allowing earlier entry, increases the odds of at least having more of a price run-up in more trades before the reversal happens. Bigger profits, bigger cushion.

Here are the rules:

Entry

If the parabolic sar reverses phase, then open a position in the direction of the parabolic sar's new phase.

(That is, if the parabolic sar is bullish, then open a bull position; bearish? bear position.)

Bull Position Exits

Stop/loss:
• Has the price traded below the highest high since the position was opened less double the ATR?
• If yes, then exit the position immediately.

Trend change:
• Has the price closed below the prior day's close on two consecutive days?
• If yes, then exit at or near the market close on the second day.

Parabolic SAR phase change:
• Has the parabolic sar changed phase?
• If yes, then exit at or near the close on the day of the change.

Bear Position Exits

Stop/loss:
• Has the price traded above the lowest low since the position was opened plus double the ATR?
• If yes, then exit the position immediately.

Trend change:
• Has the price closed above the prior day's close on two consecutive days?
• If yes, then exit at or near the market close on the second day.

Parabolic SAR phase change:
• Has the parabolic sar changed phase?
• If yes, then exit at or near the close on the day of the change.

Timing

This strategy is a full-time strategy. When the entry signal switches from bull to bear, then the position should be closed and immediately re-opened in the opposite direction.

That's not always possible in stock and option accounts having less than $25,000, which are subject to U.S. regulators (rather silly) restrictions on day-trading.

In that case, then the reverse trade can be opened at the start of trading the next day.

(Waiting can also have the advantage of making it easier to avoid whipsaws.)