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Parabolic SAR (parabolic stop and reverse) is one of the most popular trend-following indicators. Its appeal is that it not only helps in identifying the prevailing trend, but also when the trend ‘stops and reverses’.
Parabolic SAR was developed by J. Welles Wilder Jr., and when plotted on a chart, it prints parabolas (dots) that track the price action accordingly. A bullish parabola will be printed below the price when it is trending upwards, whereas a bearish parabola is printed above the price when it is trending downwards.
A bullish parabola will stop and reverse when the trend turns lower, and vice versa. The parabolas or dots that are below the price, always rise. In comparison, the parabolas above the price will always fall.
As a result, these dots track the price of an asset and they are able to pinpoint price reversals when they occur. This makes Parabolic SAR one of the best indicators that can help capture optimal entry and exit points in a trending market.
Parabolic SAR belongs to the broader group of trend-following technical analysis indicators. Other common indicators in this group include Moving Averages and Ichimoku Kinko Hyo. As a trend following indicator, Parabolic SAR is usually prone to giving out false signals in ranging or sideways markets.
Calculation of Parabolic SAR
The computation of Parabolic SAR is done in such a manner that it will ensure the parabolas (dots) are as close as possible to the price action. This ensures that traders are able to confirm existing trends or easily spot a reversal.
Parabolic SAR (PSAR) is calculated using the formula below:
Uptrend: PSAR = Previous PSAR + AF (EP – Previous PSAR)
Downtrend: PSAR = Previous PSAR – AF (Previous PSAR – EP)
- EP is Extreme Price. In an uptrend, EP is the highest high. In a downtrend, EP is the lowest low.
- AF is an Acceleration Factor. The default AF is usually 0.02, with most platforms allowing an AF value of up to 0.20.
The formula above ensures that a parabola will be printed below the price in a rising market; and above the price in a falling market. If the price falls below the rising parabolas, the parabolas will jump on top of the price. Likewise, if the price rises above the falling parabolas, the parabolas will drop below the price. Logically, the bigger the Acceleration Factor, the faster the parabolas will converge with the price.
Reading Parabolic SAR
Reading Parabolic SAR is simple and straightforward. When the parabolas (dots) are below price candlesticks, it denotes a bull market and traders should seek opportunities to place buy orders; whereas when the parabolas are above price candlesticks, it implies a bear market and traders should seek opportunities to place short sale orders.
As a rule of thumb, a trend reversal can be confirmed when three consecutive parabolas form on the opposite side. For instance, during an uptrend, a trend reversal would be confirmed after three consecutive parabolas print on top of the price action.
Trading with Parabolic SAR
Here is how to decipher the price information delivered by Parabolic SAR:
- Capturing Trend Moves
As discussed above, the Parabolic SAR is ideal for trading trending markets, especially long-lasting ones. When the parabolas are below the price, the idea is to buy; when they are above the price, the idea is to sell. The slope of the parabolas also indicates how momentous a trend is; the steeper the slope, the more momentous the trend, and vice versa.
- Exiting Trade Positions
The Parabolic SAR provides excellent exit signals in a trending market. The idea is simply to exit a trade position when the parabolas flip to the other side of the price. As mentioned above, the optimal time to confirm a trend reversal is when three parabolas print on the opposite side of the price. This would be a signal to close out a trending position, but Parabolic SAR can also help in placing trailing stops.
In trending markets, the Parabolic SAR will print consecutive parabolas. These will provide a good guide in placing trailing stops that will not only help to protect one’s capital, but secure the rewards, when prices are trending strongly.
Parabolic SAR Trading Strategies
Parabolic SAR is only ideal in trending markets. This means that it is important to qualify trends before using Parabolic SAR signals. The best trading strategies with Parabolic SAR will be those that ‘partner’ with other technical indicators that will provide confluence signals to confirm an established trend in the market.
Here are indicators that work well with Parabolic SAR:
- Parabolic SAR and ADX
The ADX (average directional index) is one of the best oscillators that qualify trend direction as well as momentum. ADX has a centreline at 50, and a reading above this denotes a momentous trend that is worth trading. A reading below 50, signals that a trend is losing steam and the market may start moving sideways. With regards to trend direction, ADX has two lines: the +DI (green line) and the –DI (red line). When the green line is above the red line, it implies an uptrend is in place; and when the red line is above the green line, it implies a downtrend is in place. When combined with the ADX, Parabolic SAR is able to deliver high probability trading signals in trending markets.
- Parabolic SAR and Moving Averages
Moving averages are probably the most popular technical indicators used by traders. Traders combine multiple moving averages to confirm trends and to spot reversals early enough. When prices are above a moving average, it means an uptrend is in place; prices below, denote a downtrend. The slope of the moving average indicates how momentous a trend is. Moving average crossovers also help traders spot trend reversals in the market early. With the Parabolic SAR being a lagging indicator, combining it with moving averages can help confirm prevailing trends as well as detect potential reversals early.
Trading on Parabolic SAR with AvaTrade
Take advantage of Parabolic SAR signals when trading on AvaTrade platforms and enjoy plenty other benefits such as:
- Advanced Trading Platforms – AvaTrade offers access to robust and superior trading platforms packed with numerous trading tools and resources to enhance your trading activities.
- Multiple Timeframes – Use the Parabolic SAR on up to 21 chart timeframes available on the trading platform.
- Demo Account – Try out different Parabolic SAR strategies with an AvaTrade demo account. Use this account to boost your trading accuracy, without the risk of losing any money.
Main Parabolic SAR Indicator FAQ
The Parabolic Stop and Reverse Indicator, better known as the Parabolic SAR Indicator, is an indicator that is used to forecast the short term momentum of an asset. The reason it is often used is not to determine when to enter a trade, but rather for where to place a stop loss to protect against a sudden shift in the market. One of the unique features of this indicator is that it assumes the trader is always fully invested in the market, either long or short. That makes it particularly useful for use in trading systems that never exit the market, but only switch between long and short positions
The Parabolic SAR is best used in steadily trending markets. If the market is choppy or range-bound the trader will find himself whipsawed in and out of trades when using this indicator. This type of whipsaw can be avoided by adding a confirming indicator to the study of the market. J. Wells Wilder, the creator of the parabolic SAR, recommended also using the ADX to get a more accurate read on the strength of any trend. In a trending market solid trades with long-term profits are more likely.
The use of other indicators alongside the Parabolic SAR is necessary to avoid whipsaws and many failed trades. One of the best strategies is to use the Parabolic SAR in combination with two moving averages. These moving averages are there to verify that a trend reversal is actually taking place when signaled by the Parabolic SAR. Typically a 40-period moving average and a faster moving 20-period moving average are used. A trade signal is only generated if the Parabolic SAR signals a trend reversal and the moving averages cross to indicate the same change in trend.
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** Disclaimer – While due research has been undertaken to compile the above content, it remains an informational and educational piece only. None of the content provided constitutes any form of investment advice.