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PARABOLIC TRADING SYSTEM
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The Parabolic trading system was described in 1976 by J. Welles Wilder, Jr. It was named after the pattern of its stops during runaway moves, which resembled a parabola. The Parabolic system is now included in many software packages.

Parabolic aims to catch trends and to reverse positions when trends reverse. Its unique feature is that it responds to the passage of time as well as to changing prices. Most traders focus on prices but ignore time (see Section 36).

How to Construct Parabolic

Parabolic is a reversal system, designed to keep a trader in the market all the time. When Parabolic stops you out of a long position, it tells you to go short at the same price. If it stops you out of a short position, it tells you to go long at the same price and time. This method worked well during the inflationary markets of the 1970s, but has led to many whipsaws in later years. Now Parabolic should be used selectively, only when markets are trending.

Parabolic is based on a good old rule — move your stops only in the direction of the trade and never against it. If you are long, you may raise your stops but never lower them. If you are short, you may only lower your stops.

Parabolic stops are set daily, using a formula:

Sto Ptomorrow = Stop today + AF • (EP trade - Sto Ptoday )

where Stop loday = the current stop.

Stop tomoriow = the stop for the next trading day.

EPtrade = tne extreme point reached by the market in the

current trade. If a trader is long, EP is the highest high reached since the day he bought. If a trader is short, EP is the lowest low reached since the day he went short.

AF = the acceleration factor. This unique tool deter-

mines how fast to move a stop in the direction of a trend. AF depends on the number of new highs since the entry into a long trade or the number of new lows since the entry into a short trade.

On the first day in a trade, Acceleration Factor equals 0.02. This means that the stop is moved by 2 percent of the distance between the extreme point

and the original stop. AF increases by 0.02 each day the rally reaches a new high or a decline reaches a new low, up to the maximum of 0.20.

If the market reaches 3 higher highs during a long trade, AF equals 0.08 [0.02 + (0.02 • 3)], and if the market reaches 9 new highs, AF rises to its maximum of 0.20, or 0.02 + (0.02 • 9). In the latter case, the daily stop gets moved by 20 percent of the distance between the extreme point of the trade and the latest stop.

In the beginning of a trade, Acceleration Factor is small and stops move slowly. As the market reaches new highs or new lows, AF increases and stops move fast. If the market does not reach new highs or lows, AF keeps moving stops in the direction of the trade. By doing so, Parabolic forces traders to get out of trades that go nowhere.

Many traders change the Acceleration Factor. They adjust the size of the basic 0.02 step and the 0.20 maximum size of AF. Some increase them to make the system more sensitive, others decrease them to make the system react slower. The size of a step often varies from 0.015 to 0.025 and the maximum size of AF from 0.18 to 0.23.

Trading Psychology

Losers go broke by hanging onto losing positions and hoping for a reversal. The Parabolic system protects traders from indecision and imposes an iron discipline on them. It sets a stop the moment you enter a trade and tells you to move it in the direction of the trade.

If you go long or short but prices remain flat, it gives you a message that your timing was wrong. You would not have bought or shorted unless you expected prices to move right after you put on a trade! Parabolic does not let you hang onto a trade that goes nowhere. It moves stops in the direction of the trade, saying in effect "Put up or shut up."

The Parabolic system is extremely useful during runaway trends. When prices soar or crash without a pullback, it is hard to place stops using normal chart patterns or indicators. Parabolic is the best tool for placing stops under those conditions.

Trading Rules

When you begin using Parabolic in any given market, go back several weeks to calculate its stops. Adjust Parabolic stops daily, with one exception: If it tells you to move the stop into the previous day's range, don't do it. Stops should be kept outside of the previous day's range.

The Parabolic system works well in trending markets but leads to whip-saws in trendless markets. It can generate spectacular profits during price trends but chop up an account in a trading range. Do not use it as an automatic trading method.

The original Parabolic was a true reversal system. When a trader was long one contract, it told him to place an order to sell two contracts if his stop was hit. Then he sold his long position and automatically went short. When a trader was short one contract, Parabolic told him to place an order to buy two if his stop was hit. Then he covered his short position and went long.

A trader is better off entering the market using some other trading method, such as the Triple Screen trading system, and then switching to

Parabolic only if he finds himself riding a dynamic uptrend or a downtrend

•  When you find yourself in a strong uptrend, go over the past several
weeks of data and apply the Parabolic system. Having updated
Parabolic to the current day, begin calculating stops daily and use
them to protect profits on your long position.

•  When you find yourself short in a fast downtrend, apply Parabolic to
the past several weeks of data and update it to the present day. From
that day on, calculate its stops daily to protect profits on your short
position.

The Parabolic system ties together price and time and moves stops in the direction of the trade. The faster the trend, the faster Parabolic moves its stops. Parabolic is an excellent tool for getting the most out of a strong trend that was entered using any method.

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