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06/04/13 Incredible Charts: Safezone Indicator
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Table of Contents
Safezone Stops
Safezone Trading Signals
Example
Safezone Setup
Safezone Formula
Define the Trend
Directional Movement
Directional Movement Days
When the Trend is UP
When the Trend is DOWN
Safezone Evaluation
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Indicator Guide > Trail ing Stops > Safezone Indicator
Indicators A ~ Z > Q ~ U > Safezone Indicator
Education > Trail ing Stops > Safezone Indicator
Safezone Stops
Traders adjust their stops over time in the direction of the trend in orderto lock in profits. As an alternative to Moving Average and Average TrueRange trailing stop systems, Alexander Elder introduces SafeZoneStops in Come Into My Trading Room (2002).
Dr Elder designed SafeZone to eliminate the "noise" component of atrend and hopefully avoid having stops shaken out by that noise. Heuses a 22-day Exponential Moving Average to define the trend, but Iprefer a longer (63-day) exponential moving average. Elder thencalculates directional movement in a similar fashion to Welles Wilder'sDirectional Movement System and applies a multiple of between 2 and3 to determine the trailing stop.
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Safezone Trading Signals
Safezone stops are primarily used to time exits from a trending market. Use the exponential moving average todetermine the trend and select the Safezone long or short option.
Exit long positions when price crosses below the Safezone stop.
Exit short positions when price crosses above the Safezone stop.
Safezone cannot be used to signal entries as with some stop-and-reverse systems.
EXAMPLE
The RJ CRB Commodities Index late 2008 down-trend is displayed with Safezone (short, 22-day, multiple of 3)and 63-day exponential moving average used as a trend filter. Entries are taken when price makes a new 5-daylow while below the moving average (or 5-day high when above the MA).
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Mouse over chart captions to display trading signals.
1. Go short [S] when price is below Safezone and closes below the 63-day exponential moving average
2. Exit [X] when price crosses above the Safezone Line
3. Go short [S] when price makes a new 5-day low while below the 63-day MA
4. Exit [X] when price crosses above
5. Go short [S] when price makes a new 5-day low while below the 63-day MA
6. Exit [X] when price crosses above
7. Go short [S] when price makes a new 5-day low while below the 63-day MA
8. Exit [X] when price crosses above the Safezone Line
No long trades are entered while price is below the 63-day exponential moving average, nor short trades whileabove.
Safezone Setup
Default settings for Safezone are a 22-day period and a multiple of 2.5 times. Longer term traders may opt forwider multiples of 3.5 or 4.0.
See Indicator Panel for directions on how to set up an indicator — and Edit Indicator Settings to change thesettings.
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Safezone Formula
Define the Trend
First compare Closing Price to an exponential moving average to define the trend.
If Closing Price is above the moving average for the selected period, that means that the trend (and the
MA slope) is upward.
If Closing Price is below the moving average, the trend is downward.
Directional Movement
The second element is Directional Movement. This is calculated in a similar fashion to DI+ and DI- in theDirectional Movement System:
+DM = Today's High - Yesterday's High (when price moves upward)
-DM = Yesterday's Low - Today's Low (when price moves downward)
The difference is that you can have both +DM and -DM on the same day. If there is an outside day then bothcalculations will be positive. For an inside day both calculations are zero.
Directional Movement Days
Calculate the number of days with +DM in the selected period; and the number of -DM days. Elder uses thesame selected period for Directional Movement as he does for the moving average, but there appears to be noreason why this could not be varied.
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reason why this could not be varied.
When the Trend is UP
Calculate -DM Average:
Sum of -DM for the period / Number of -DM days
Then calculate the Stop Level for today:
Today's Stop = Yesterday's Low - 2.5 * -DM Average
To delay/prevent the stop from being lowered, use the maximum of the last 3 days' stops.
When the Trend is DOWN
Calculate +DM Average:
Sum of +DM for the period / Number of +DM days
Then calculate the Stop Level for today:
Today's Stop = Yesterday's High + 2.5 * +DM Average
To delay/prevent the stop from being raised, take the minimum of the last 3 days' stops.
Note: We use a multiple of 2.5 in the above example, but any multiple between 2 and 4 is acceptable.
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Safezone Evaluation
SafeZone has a number of strengths:
Stops are less likely to move lower during an up-trend (or higher during a down-trend);
SafeZone does not assume that the trend has changed every time that your stops are hit; and
SafeZone uses Directional Movement rather than ATR as a measure of volatility. This is an excellent
concept. It attempts to isolate counter- trend movement as the risk factor when following a trend and
removes the other irrelevant component of volatility (movement in the direction of the prevailing trend). A
runaway trend (or blow-off) may show little or no counter-trend movement, meaning that stops move
tighter as the trend accelerates into a blow-off.
Potential weaknesses:
SafeZone fails to adequately distinguish between counter-trend movement and movement in the direction
of the prevailing trend — at the start of a trend or if the trend reverses within the selected time period. All -
DM and + DM is treated equally, whether the trend is up or down, giving an incorrect reflection of counter-
trend movement.
The relatively short time period over which directional movement is calculated may not adequately reflect
potential counter-trend movement.
SafeZone relies on an exponential moving average to indicate trend direction, introducing some lag. There
is nothing, however, to stop the trader from substituting another trend indicator in place of the moving
average.
Overall, a clever system.
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