Understanding the Parabolic SAR Indicator

Feeling confused with technical indicators? Then, the Parabolic SAR indicator is the easiest to use to identify entry and exit points. Developed by J. Welles Wilder in the late 1970s, this technical indicator helps you to identify the direction of a trend.

This blog explains what is Parabolic SAR indicator in more detail, its calculation, interpretation, and benefits.

What is Parabolic SAR in Trading?

The Parabolic SAR indicator helps traders identify reversal points and trend direction in price movements. This indicator includes a series of dots positioned above or below an asset price to signal potential entry and exit points.

On a chart, dots below the price signal an uptrend, and dots below the price signal a downtrend. If the price reaches or crosses the SAR dots, it indicates a possible trend reversal, and the dots move to the other side.

However, Wilder also suggested utilising this indicator in conjunction with other technical analysis indicators.

How Does the Parabolic SAR Work?

Now that you know what Parabolic SAR is, let us understand how it works. The Parabolic SAR is an indicator which primarily helps identify potential trend changes and produce trade signals. When the dots remain above the price, it signals a bearish trend and suggests a potential sell signal.

On the other hand, when the dots remain below the price, it indicates a bullish trend, meaning a potential buying opportunity.

A Parabolic SAR indicator works well in strong trending market conditions. In these time periods, this indicator accurately captures significant price movements, making your trade profitable.

However, you cannot solely depend on this indicator in sideways or ranging markets. The Parabolic SAR may generate false signals in these markets, which can lead to minor losses or profits. While the Parabolic SAR helps identify trend direction and produce trade entries, you can also employ it as a dynamic stop-loss mechanism.

Moreover, you can also manage your risks by setting the stop-loss level and protecting unrealised gains.

Calculation of Parabolic Sar

If you understand what is Parabolic SAR indicator and how it works, you can proceed to its calculation. The Parabolic SAR indicator uses the highest and lowest prices and the acceleration factor (AF) to find the position of the SAR indicator dot. The formula is:

Uptrend Parabolic SAR = Previous SAR + Prior AF (Previous EP – Previous SAR)

Downtrend Parabolic SAR = Previous SAR – Previous AF (Previous SAR – Previous EP)

In this formula:

1. EP is the extreme point, which means the highest and lowest point a price reaches during an uptrend or a downtrend.
2. AF refers to the acceleration factor, which is primarily set to a value of 0.02. You can choose the AF according to the trading style or the traded asset.

Either below or above it, the outcome from the calculations above creates a dot which is plotted against the asset price action. The dots also assist in determining the current price direction.

Interpretation of Parabolic SAR Indicator

The Parabolic SAR indicator provides a multidimensional view of market behaviour by highlighting the market’s direction. You can find potential market reversals and set stop-loss orders to manage risk.

When you can see the dots below the price, it indicates an uptrend in the price. This signals to hold the buying position. However, when the dots go above the price, it indicates a downtrend. This means you can initiate a short sale or exit from your existing position.

Benefits of Parabolic SAR

To understand what is Parabolic SAR indicator in more detail, let us have a look at the benefits of this indicator:

1. Ease of Access

   A Parabolic SAR indicator is easy to interpret, as the dots provide clear buy and sell signals.

2. Reversal Signals

   The stop and reverse feature in this indicator provides signals of trend reversals. This allows you to enter, exit, and reverse the position.

3. Appropriate for Stop-Loss Placement

   This indicator can also help you determine stop levels. These dots provide dynamic support and resistance levels, and adjust as the trend moves on.

4. Flexibility

   You can adjust the AF to make the indicator more or less sensitive to price shifts, based on your trading style.

Limitations of Parabolic SAR

1. Dependent on Other Tools

   A Parabolic SAR indicator always depends on other tools. You will be more beneficial when you use it in conjunction with other tools.

2. False Signals

   If you solely rely on Parabolic SAR for trading, it can sometimes result in false entries.

3. Avoid Volume

   It also considers price movements but not trading volume. Consequently, stocks with lower liquidity can generate false trading signals since only a few trades can move the price without the actual strength behind the move.

Sensitivity Adjustments

Choosing the correct AF is one of the biggest challenges you might face while using the Parabolic SAR indicator. If you set the AF too high, it can generate many false signals, and if it is set very low, it can miss trend reversals.

Final Thought

Understanding what is Parabolic SAR indicator is very crucial since you can experience both benefits and limitations while using this indicator. While it is easy to use and appropriate for stop-loss placement, this indicator may also produce false signals. To get appropriate results, you should use it with other indicators.

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Frequently Asked Questions

1. Is Parabolic SAR a reliable indicator?

Yes, a Parabolic SAR indicator is reliable. However, its reliability depends on the timing and process of using it. In choppy movements, this indicator generates false signals.

2. How to use the Parabolic SAR indicator effectively?

You can use the Parabolic SAR indicator to identify trends and for stop-and-reverse trading. If the SAR dots go below the price, you should buy; if the flip is above the price, you can place a sell order.

3. What are the Parabolic SAR dots?

The Parabolic SAR dots show an asset’s potential trend direction. When these dots go below the price, an uptrend is indicated. While it goes above, it indicates a downtrend. These dots also help you identify potential reversal points when they cross the price.

4. In technical analysis, how is Parabolic SAR applied?

In technical analysis, you can apply a Parabolic SAR indicator to identify trend direction, set stop loss, and get entry or exit signals. You can effectively use it for trailing stop losses to lock in profits since this indicator automatically adjusts as the trend moves on.