What Is the Parabolic SAR?
The parabolic stop and reverse (SAR)is a popular indicator that is mainly used by traders to determine the future short-term momentum of a given asset. The indicator was developed by the famous technician J. Welles Wilder, Jr. and can easily be applied to a trading strategy, enabling a trader to determine where stop orders should be placed.
Key Takeaways
- Parabolic SAR is a technical indicator to determine short-term momentum, helping determine where stop orders should be placed.
- Trailing stop-loss orders are placed at the SAR value, where a move beyond that level will signal a reversal.
- The indicator is graphically shown on the chart of an asset as a series of dots, which are placed either over or below the price—depending on the momentum of the asset.
- The indicator assumes the trader is fully invested in a position at any given time and tends to perform best in markets with a steady trend.
- Note that the calculation of the parabolic SAR is rather complex.
Understanding the Parabolic SAR
One of the most interesting aspects of this indicator is that it assumesa trader is fully invested in a position at any point in time. For this reason, it is of specific interest to those who developtrading systems and traders who wish to always have money at work in the market.
The parabolic SAR indicator is graphically shown on the chart of an asset as a series of dots placed either over or below the price (depending on the asset's momentum). A small dot is placed below the price when the trend of the asset is upward, while a dot is placed above the price when the trend is downward.
The calculation of this indicator is rather complex and goes beyond the scope of how it is practically used in trading. Your trading platform may calculate it for you, allowing you to make adjustments as necessary to suit your trading strategy.
Many traders will choose to place their trailing stop-loss orders at the SAR value, because a move beyond this will signal a reversal, causing the trader to anticipate a move in the opposite direction. In a sustained trend, the parabolic SAR is usually far enough removed from price to prevent a trader from being stopped out of a position on temporary retracementsthat occur during a long-term trend, enabling the trader to ridethe trend for a long time and capture substantial profits.
Markets and the Parabolic SAR
The parabolic SAR performs best in markets with a steady trend. In ranging markets, the parabolic SAR tends to whipsaw back and forth, generating false trading signals. Wilder recommended augmenting the parabolic SAR with the use of theaverage directional index (ADX) momentum indicator to obtain a more accurate assessment of the strength of the existing trend.
Traders may also factor in candlestick patterns or moving averages. For example, price falling below a major moving average can be taken as a separate confirmation of a sell signal given by the parabolic SAR.
How to Trade With the Parabolic SAR
Parabolic SAR provides information about trend directions. It's best used in a steady market, as it's possible it will produce false signals in choppy markets, or when pricing moves sideways. If you're using the parabolic SAR to help time your entry or exit from a position, you'll want to watch for when it crosses above the security's price (meaning you may wish to sell) or below the security's price (meaning you may wish to buy). Either would indicate a trend reversal and can help you define where to place a stop-loss order to reduce your risk.
To use it in a trading platform that includes this indicator, you can toggle this indicator on and adjust the settings, including the acceleration factor, or step. The acceleration factor determines the rate of change. It's often set to 0.02 as a default, but you can adjust that figure up or down to your desired sensitivity level.
However, keep in mind that adjusting the step can influence the signals you receive, so you'll want to use it in conjunction with other indicators to confirm your reading of the trends.
Indicators to Use With the Parabolic SAR
Other technical indicators that pair well with the parabolic SAR to inform your trades include:
- Average directional index momentum
- Candlesticks
- Moving averages
What Does the Parabolic SAR Tell You?
Traders use the parabolic stop and reverse to identify momentum and determine where to place stop orders.
Is Parabolic SAR Reliable?
The parabolic SAR works best in conjunction with other indicators to confirm trends and inform your decision-making.
What Is a Good Parabolic Sar Setting for Day Trading?
Most trading software uses a default setting of .02 for the acceleration factor for parabolic SAR. You may wish to adjust this setting (in small increments) to determine what works best for your trading style and goals.
The Bottom Line
The parabolic stop and reverse is a technical indicator developed by J. Welles Wilder, Jr.It, alongside other important indicators, can be a useful way to determine where to place your stop orders to minimize risk in your trades. Your trading platform may include the parabolic SAR as an indicator, so you may not have to calculate it yourself. Still, it's important to understand how it's used so you can avoid false signals and get the most reliable insights.
