What is the Parabolic SAR indicator?
The Parabolic Stop and Reverse, more commonly known as the Parabolic SAR, is a trend-following technical indicator developed in 1978 by J. Welles Wilder Jr. Welles was an inventive mechanical engineer who turned to a financial and technical analyst who pioneered a variety of the technical analysis tools and instruments that financial traders still use to this day. J. Welles Wilder Jr. was also the writer of numerous financial books including the “ New Concepts in Technical Trading Systems ”.
Trading Tools invented by Wells are the Relative Strength Index (RSI), Average Directional Index (ADX), and Average True Range (ATR) among others. The Parabolic SAR is displayed as a single parabolic line with dots or points below the price bars in an uptrend, and above the price bars in a downtrend. Developed to help traders identify Buy signals and Sell signals for current trends and determine the ideal time to enter and exit trades based on an asset’s momentum.
This is probably the easiest technical indicator to comprehend, locate and trade because it assumes that the price is either going up or down. A trailing stop loss and reversal method – SAR - or stop and reversal method, is used to identify appropriate and successful exit points and entry points. This tool is best used in trending markets, and that have long rallies and downturns.
How to trade using the Parabolic SAR Indicator?
Parabolic SAR, has a very comprehensible way of identifying market trends. When the dots move beneath the price limits, they indicate a strong trend signal. Same when the dots move above the price Limits, indicating a strong trend.
This technical indicator is constantly providing traders with trading signals. That can be positive if the price is making big fluctuations resulting in big returns most of the time. When the price is more stable, these constant trade signals can result in consecutive loss-making trades and expose a trader’s capital to undesirable risks. Thus, it is better to have a broader view of the price movements in a day for better and more accurate trend identification.
Parabolic SAR strategies
Moving average trendlines alongside other technical indicators can also be used to locate the overall trend directional movement. When a trend is present, consider taking trade signals in the direction of the overall trend. For instance, if there is a bullish trend according to market and technical analysis, consider taking short trade signals when the dots surpass the top limits of the price bars. It is probably better to indicate the exit point of a trade when the dots flip below the price bars. In this way, the indicator is utilized for its strength in identifying and locating trending volatility and trending markets.
Identifying Parabolic SAR trends?
The parabolic SAR appears as a series of dots that move between the top and low limits of the price candlesticks. A trading signal is considered to be bullish (BUY) when the dots move below the price candlestick. Vice versa, a trading signal is considered a bearish signal (SELL) when the dots move above the price indicating that momentum is more likely to remain in a downtrend that favors short positions trading, selling.
In times of market instability and high volatility, the dots are likely to cross over the price limits – from one side to another. Having in mind that pricing is the delayed reflection of the market momentum on the global markets’ mirror, any flip can be considered to be an indicator of a potential reversal right around the corner.
Dot spacing could be equally revealing using the Parabolic SAR is a trend identification tool. A chain of dots will start close together and spread further apart as momentum accelerates and the strong trend escalates. To locate a trend using the Parabolic SAR in the forex markets, one needs to look for a price chain starting in the lower left-hand quadrant and moving diagonally to the upper right quadrant crossover, or vice versa.
Parabolic SAR calculation
The Parabolic SAR (PSAR) formula is quite easy to calculate since it uses the most recent extreme price (EP) in association with an acceleration factor (AF) to determine where the indicator dots will move next. The recent extreme price (new high) is the highest high for an uptrend and the lowest low (the lowest price) for a downtrend, updated every time a new extreme price is reached. While, the default of 0.02, increasing by 0.02 each time a new extreme price is reached, with a maximum of 0.20. The Parabolic SAR is calculated almost independently for each trend in the price though.
Parabolic SAR calculation Uptrend:
PSAR = Prior SAR + Prior AF (Prior EP - Prior SAR)
Parabolic SAR calculation Downtrend:
PSAR = Prior SAR - Prior AF (Prior SAR - Prior EP)
This calculation creates a dot below the up-trending price action, or above the falling price action. These dots are essential to track the current price direction. The dots are always present, though, which is why the technical indicator is called a stop and reverse or stop loss and reversal. When the price falls below the rising dots, the dots flip on top of the price bars. The digital era gave modern-day societies the advantage of superior technologies which introduced trading platforms and trading systems – such as the MT4, MT5, Autocharist, the Iress Trading Tools for Professionals, FP Markets WebTrader, and Mobile App - to the global forex markets. All these calculations might be automated with such an abundance of trading tools and technologies but it's still helpful to know how to crunch the numbers for yourself.
When to Use the Parabolic SAR and when not to
The Parabolic SAR is a powerful tool used for generating returns by entering the trade during a trend during low volatility and steady market. It is also often used for day trading. The sideways price move is when the SAR produces false signals that might lead you into positions you later regret. Ιn cases where trends aren’t strong, the parabolic SAR doesn’t offer much value, making it an unreliable tool in some situations. The parabolic SAR is used to gauge a stock's directional movement and for trailing stop-loss orders, it can also guide your decision-making, especially in a volatile market. But when market conditions are stable or price movements aren’t showing strong momentum, consider using other tools to evaluate trade options. Always evaluate all the risks involved in each situation individually by carrying out your fundamental analysis and technical analysis of each market that you wish to trade before entering a position, so to avoid loss-making trades.
Indicators complementary to the Parabolic SAR
Combining other trading indicators with the parabolic SAR will help you determine when to enter trades and exit trades for better and appropriate risk management. Wilder used the parabolic SAR in conjunction with his ADX to identify a trend’s directional movement and momentum before entering or exiting a position. Moving averages indicators, such as moving average convergence divergence (MACD) and Bollinger Bands, are often used to confirm the buy and sell signals that manifest during parabolic SAR crossovers. The RSI can be an effective tool for trend illustration based on whether overbought or oversold conditions are present, which is a very important driver of the trending movement. The ATR can help measure market volatility to evaluate not only the potential price moves driven by a trend but also whether the current market conditions are properly served by the parabolic SAR. Always remember that composure pays more than agitation.
Advantages of Using the Parabolic SAR Indicator
The biggest benefit of the parabolic SAR is that this indicator highlights the strength of a trend at the moment of action. Once entering a position, the strength of the trend can help you decide whether to keep your position or close it out. Timing is of the essence in the forex market. Thus, the parabolic SAR is one of the most powerful trading tools to time a trader’s exit point when trying to maximize returns and minimize the risks from any given position.
Parabolic SAR Risks
Combining other indicators alongside the Parabolic SAR can be helpful for trend illustration, for proper risk management, and better entry position and exit position timing. Traders in the forex global markets often use a combination of other indicators in addition to the parabolic SAR to distinguish weakening trends and false signals that do not lead to reversals. As a result, traders often miss out on additional profits that other indicators might have convinced them to patiently wait for.
Learn how to use the Parabolic SAR Indicator
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