The Parabolic Arc Pattern or How To Profit from Euphoria and Bubbles
There are certain people in the financial community who study extreme sentiment swings in price. That means bubbles, panics, moments of mania, and everything else reflected in a chart that’s spiking higher or crashing lower. One of these people is Suri Duddella or SuriNotes.
In this conversation we focus on one of his primary skillsets. That is the Parabolic Arc. As you read this interview you will learn how he uses the Parabolic Arc and how it’s helped him profit on extreme price swings like the infamous crash of Valeant. So if you think you are great at calling bubbles or finding bottoms, read what a true expert has to say about that.
1. What is the Parabolic Arc?
Parabolic Arc chart patterns are generated when steep rise in prices are caused by irrational buying and intense speculation. Parabolic Arc patterns are rare but they are reliable and are generated in mega bull trends. These patterns trend gradually making higher highs and lower lows in the beginning stages but can be volatile in the exhaustion and reversal stages.
Irrational buying in the public generates a strong rally to push prices vertically, followed by a steep sell off. Examples of this market types are the NASDAQ bullish markets during 1990-2000 (retraced 80%) and Gold prices from 2000-2011 (retraced 62%).
Parabolic arc is a reversal pattern and has a very predictable outcome. Although they are predictable, they are relatively difficult to trade since the market sentiment is bullish and may be relatively tough to point reversals to trade. Most Parabolic arc patterns have a significant correction of 62-79% of its price rise (from the top).
The basic ideas behind Parabolic Arc patterns:
- Pattern is easy to spot but difficult to trade with excessive volatility.
- Most Patterns retrace to 62-78% of its rise. 50% retracement is first target.
- Do not overstay in your trades
- Stay away from “Parabolic Arc” patterns buying (after retracements) as you truly never
- know where/when it will start reversing.
- Do not expect the price to return to Parabolic Arc highs for a very long time.
Trade: In Parabolic Arc patterns, prices move up vertically and eventually the acceleration comes to a stop and then reverses. Prices start showing lower-lows and may attempt to regain the top again. Draw a channel connecting the top and bottom of the pattern. Enter a “short” trade at the second failed attempt to test the peak or at the channel trend line breakdown connecting the major swings.
Target: Measure the distance of the rise from the base to the top of the pattern. Most Parabolic Arc patterns return to the 62-79% of its rise.
Stop: Protect the trade by placing few ticks above the high of the Parabolic Arc.
2. Do you mostly trade this pattern on the way up and way down?
I primarily trade Parabolic Arc patterns on its way down as I look at them as reversal patterns.
Let me explain why….
The Parabolic pattern on its rise may become obvious in the beginning to mid-range of its build. It may suggest Parabolic Arc at different ranges on the rise and may be traded with range/channels breakouts. Trading rising markets have fear built into it as traders do not know where and when it would reverse since no other data points are available. Traders do need to exercise extreme caution trading rising Parabolic Arc patterns.
It becomes a climax or exhaustion trade once it achieves vertical trend in panic buying. This is where for me Parabolic Arc becomes more interesting as I start to look for failures and clues of reversal in its trend. I have built an auto detection algorithm/indicator for Parabolic Arc patterns and use it to point the potential level of failure/trade levels and targets. I scan almost every day for newer ideas using Parabolic Arcs and potential opportunities. Also, the reversal in Parabolic Arc pattern falls much faster than rise in the pattern (in most cases).
3. What kind of trader are you? What is your timeframe?
I am purely a Patterns based Algorithmic Trader. I trade Chart Patterns with Market Context and with a very defined and structured rule set. I also trade confirmed trade/patterns after its retracements. I built 100% Automation of Pattern Recognition and its Trade Logic using TradeStation Software. I trade Intraday Emini Futures and trade Stocks/Options from a swing trading (1 day to Months) perspective.
4. What’s the most extreme parabolic arc curve you’ve seen in the last 5 years?
One of the extreme Parabolic Arc pattern I have seen in the recent years: Valeant Pharma ($VRX). Valeant Pharma rose from a low of $5.65 (in 2009) to $263.81 (July 2015). A massive rise (4500%) in 6 years in a Parabolic Arc format. Even though it had a brief pause in Parabolic Arc (without an exhaustion move) during 2014, late 2014 to July 2015 it rallied from $106 to $163 (148%) to complete exhaustion move. Exhaustion move itself does not guarantee a fall, but a series of events followed by technical breakdowns tell the parabolic move may be done.
The first clues of Parabolic Arc breakdown came in Sep/Oct 2015 as the VRX fell below (around 200) the mid channel on negative reports. Now it is all is a waiting game. Once Parabolic Arc patterns confirm its breakdown is almost a guaranteed death spiral. Parabolic Arcs usually LONG term patterns. Some are swift but most patterns take a long time to rise and at least 1/3 to 1/2 of its rise (time) to fall. The initial targets in VRX are 62-79% (90-103). VRX rise was $260. It gave pretty good target ranges to 62-79% (90-103). Not quite sure why some of the patterns rise from once it reaches 62-79% levels but VRX had a brief pause in its fall (Nov. ’15 to Jan. ’16) but it started its death spiral. I really do not have any research to support Parabolic Arcs beyond 79% of its retracement but VRX is now trading around $20 (June 28, 2016), almost 90% retracement from its high of $263.
5. What kind of market psychology goes into this pattern? What do you think it represents?
I have a great respect for Market Psychology and spend a great amount of time reading and improving my own trading psychology, but I am afraid I am not good at explaining psychology. Here is what I think…
Parabolic Arc patterns consist of both panic buying and panic selling scenarios. As a stock breaks out and starts to rise investors tend to feel its rising cycle is never going to end and build confidence based on hysteria. This misjudgment provides a blind faith in investors as the stock chart takes exponential curve based structure. In the state of rising parabolic arc, the price continues to rise without a pause and/or with series of upside gaps. The stock price itself could multiply double or triple or quadruple in this process every year.
In its last stage, parabolic arcs move vertically as panic buying (climactic buy) in an absence of sellers on some unfounded expectations/news/events. Most of this climactic buy is driven by momentum and amateur traders, in fear of being left behind. Finally, the reality sets in with some negative event or unfavorable news and it takes out the buyers, this creates Panic Selling. The prices reverse dramatically with large ranges as the initial buyers take profits. The traders who bought at the top also start to sell on panic. Hence, in most cases Parabolic Arcs are great trades after it reaches its panic buying.
Here are some Parabolic Arc Examples. The green shaded area shows the potential target range.
If you enjoyed this interview, please let SuriNotes know! You should also head to his website SuriNotes.com where blogs, studies, and charts the stock market.
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