Parabolic SAR is a technical analysis indicator developed by Welles J. Wilder. It was first described in Wilder’s 1978 book, New Concepts in Technical Trading Systems. SAR stands for “Stop and Reverse”. The author had himself called this indicator the “Parabolic Time/Price System.”
Parabolic SAR is considered one of the basic indicators and is included in our Mobile App platforms (www.plindia.com/plmobileapp). The indicator was developed with the purpose of identifying possible trend changes. Being a unique indicator with high practical potential, Parabolic SAR is combined with other indicators for maximum accuracy.
How does the Parabolic SAR work?
The idea behind the indicator is quite simple. When the price crosses one of the Parabolic SAR dots, the indicator is expected to turn around and appear on the opposite side of the price line. Such behavior can be a signal of an upcoming trend reversal or at least a trend slowdown.
When the Parabolic SAR touches the price, the trend changes its direction. This risk-following indicator can be used to estimate optimal entry/exit points, predict the trend direction and forecast future behavior of the price action.
- If the dots are above the price, then the trend is likely to be down
- if the dots are below the price, the trend is likely to be up.
As the price move comes to an end, the parabolic SAR moves steadily closer to the price until the price ends up touching the dots – the SAR then begins to form on the other side of the price, indicating that the price is changing direction.
The Parabolic SAR has three primary uses:
- Highlighting the current price direction (trend).
- Providing potential entry signals.
- Providing potential exit signals.
In addition to dot position, dot spacing is also revealing. At the beginning of a new trend, the PSAR dots will start close together and spread farther apart as momentum accelerates and the trend develops more fully. As momentum slows, the PSAR will catch up to price, and the dots will once again become more compressed.
When to Use a Parabolic SAR
The PSAR operates on the premise that price is always trending up or down and never stagnating. For this reason, it’s ideal for trending markets that oscillate between high and low periods but maintain a diagonal trajectory.
Also keep in mind that the PSAR is a lagging indicator- All lagging indicators are prone to creating false signals and thus favor trend-following strategies that can withstand smaller market stopouts.
According to Welles J. Wilder himself, the indicator should only be used during strong trends, that usually do not exceed 30% of the time. The use of the Parabolic SAR on short time intervals and during the sideways movement is not advised as the indicator loses its predictive potential and can return false signals.
It is therefore best to combine it with indicators designed to determine the strength of a trend, not the direction of the trend. One of the most common indicators used to identify the strength of a trend is the Average Directional Index (ADX).
Interested readers may use the PL Mobile App’s real time charting facilities (see pic below) to check out PSAR positioning and combine it with any other indicators all available in our library! If you wish to learn more about technicals or strategies, do register for our forthcoming sessions of the PL Academy (Mail : placademy@plindia.com)
The PL Mobile App Rendition of PSAR
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Post Script: The SAR Calculation
The Parabolic SAR (PSAR) indicator uses the most recent extreme (highest and lowest) price (EP), along with an acceleration factor (AF), to determine where the indicator dots will appear.
The Parabolic SAR is calculated as follows:
Uptrend: PSAR = Prior PSAR + Prior AF (Prior EP – Prior PSAR)
Downtrend: PSAR = Prior PSAR – Prior AF (Prior PSAR – Prior EP)
Where:
EP = Highest high for an uptrend, and lowest low for a downtrend updated each time a new EP is reached.
AF = Default of 0.02, increasing by 0.02 each time a new EP is reached, with a maximum of 0.20.
What this calculation does is create a dot (which can be connected with a line if desired) below rising price action, or above falling price action. The dots/line help highlight the current price direction. The dots are always present, though, which is why the indicator is called a ‘stop and reverse’. When the price falls below the rising dots, the dots flip on top of the price bars. When the price rallies through falling dots, the dots flip below the price below.