What indicators can be used to help determine stop levels? The Parabolic SAR (PSAR)
or the Average True Range (ATR). The pros to the Parabolic SAR is that the stop
levels (dots on the chart below) work good in a strong trend but don’t work good
at all in ranges.
Another alternative is the ATR. This one can be effectively used in a range or a
trend. What you’d do is take the most recent ATR levels into consideration. In this
instance, the stock has averaged around 70-80 cents a day on its daily range. So
when you buy this uptrend, you could place your stop a bit over 70-80 cents away
from your entry price. Long term traders/investors might even double or triple that
number. This at least gives you an idea of the volatility of the stock. Every stock
will have a different volatility and will therefore need a different distance between
it and its entry and stop levels. Also, the larger the time frame, the wider the
stop. So a daily chart would have a larger ATR reading than a 60 minute chart. Again,
I’d not use both of these (ATR and PSAR) on a chart at the same time as it would
just confuse. Pick only one. If the stock is ranging then there is only one smart
choice, the ATR. If it’s trending then you have two choices. Pick whichever one
speaks to you the best.
Average True Range (ATR)
The ATR is a Welles Wilder style moving average of the True Range. The ATR is a
measure of volatility. High ATR values indicate high volatility, and low values
indicate low volatility, often seen when the price is flat.
The ATR is a component of the Welles Wilder Directional Movement indicators (+/-DI,
DX, ADX and ADXR).
The ATR was developed by J. Welles Wilder and is described in his 1978 book New
Concepts In Technical Trading Systems.
Formula:
To recap: The best technical indicators are firstly trend lines/support/resistance/volume.
After that would come the versatility of the MACD. It can be left on the chart at
all times. Use only buy signals in the uptrend and sell signals in the downtrend.
Use both signals in a range.
In Trends use 2-3 of the following maximum:
1. Trend lines
2. Moving Averages
3. MACD (buys in uptrend or sells in downtrend)
4. ADX (above 30)
5. PSAR (for stops in strong trends) OR
6. ATR levels for stops
In Ranges, use 2-3 of the following maximum:
1. Support/Resistance
2. MACD – both buy and sell signals
3. Bollinger Bands
4. RSI
5. Slow Stochastics
6. ADX below 30
7. ATR levels for stops