Parabolic SAR, or Parabolic Stop and Reverse, is a trading system based on trailing stops that is also often used as Technical indicators.
As a technical indicator, the Parabolic SAR is known as the Momentum Indicator and is used to identify potential trend reversals when prices are in a strong uptrend or downtrend.
A reversal can be an uptrend turning into a downtrend, or a downtrend turning into an uptrend.
With the ability to properly utilize the Parabolic SAR, traders can determine the direction of the trend, provide suitable entry and exit points, and where to place trailing stops.
J. Welles Wilder, Jr. introduced the Parabolic SAR in his book “New Concepts in Technical Trading Systems”.
In the book, Wilder writes “The Parabolic Time/Price System“. SAR stands for “Stop and Reverse” and this is the actual indicator used in the system.
Wilder created a parabolic SAR with three main functions:
- Highlighting current trends.
- Try to predict the reversal of the current trend.
- Provides potential exit and entry signals during reversals.
This book also includes the Relative Strength Index (RSI), Average True Range (ATR), and Average Directional Movement (ADX).
The Parabolic SAR is an unconventional oscillator.
Like other oscillators, it attempts to determine whether a currency pair is overbought or oversold. However, it does not use the typical standardized 0-100 scale. Instead, it displays a series of strategically placed “dots“.
The
Parabolic SAR shows a series of points that are either above or below the price, depending on the trend.
The
point is the stop position.
When the point is above the bar, you should go short.
When the point is below the bar, you should be long.
When the stop loss is hit, you close the current trade and start a new trade in the opposite direction.
The Parabolic SAR is “always on” and constantly generates signals, regardless of whether the price is trending or not. Many signals may be of poor quality because there is no significant trend.
How to Calculate Parabolic SAR
The
Parabolic SAR is calculated from the recent “ Extreme Prices ” (EP) and “ Acceleration Factor ” (AF).
Parabolic SAR calculation depends on whether it is applied during a uptrend or a downtrend.
Uptrend:
PSAR = Prior PSAR + Prior AF (Prior EP - Prior PSAR)
Downtrend:
PSAR = Prior PSAR - Prior AF (Prior PSAR - Prior EP)
In this calculation, EP refers to the highest point of the uptrend and the lowest point of the downtrend , which is reached every time a new EP is updated .
The AF used by Wilder is 0.02.
So AF is a constant 0.02 that increases by 0.02 each time a new EP is reached, with a maximum value of 0.20.
This means moving the stop 2% of the distance between EP and the original stop.
Each change in EP increases AF by 0.02, up to maximum acceleration, in this case 0.2.
Most trading platforms allow you to overlay the Parabolic SAR onto any price chart with the click of a button.
Parabolic SAR Summary
- The Parabolic SAR is a technical indicator used by traders to try to predict whether the current trend will continue or reverse.
- The indicator is based on a parabola, which is a series of points.
- A series of points below price indicates that the current trend is bullish.
- A series of dots above price indicates that the current trend is bearish.
- A pip flip above price could signal a bearish reversal
- A pip flip below price could signal a bullish reversal.
- Avoid using the Parabolic SAR in sideways or consolidation markets as it can generate a lot of false signals.
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