How to use Parabolic SAR (Stop and Reverse) indicator
Since its introduction by its developer, J. Welles Wilder, in 1978, the parabolic SAR (P-SAR) indicator became a powerful tool for technical analysts and traders of all levels. In this article, we'll define the PSAR indicator, its formula, and, of course, the P-SAR strategy.
P-SAR stands for parabolic stop and reverse. By implication, the indicator identifies trends and also tells the trader when to close out trade and reverse the direction.
The stop and reverse feature indicate that the parabolic SAR is the indicator that enables Forex traders to choose their positions, so always in the market.
The parabolic SAR indicator works by plotting dots above and below the price, which determines your buy and sell signals. The dots rise or fall with the price according to the indicator setting called acceleration. There is an uptrend when the parabolic SAR plots below the price, and when the parabolic SAR plots over the price, the market is in a downtrend.
Parabolic SAR strategy
Parabolic SAR can indicate when to buy or sell (or go short). Sometimes, you can use it as a bullish/bearish indicator; it is bullish when the parabolic line is below the stock price and bearish when it is above the stock price. Parabolic SAR crossover works best in a trending market or in a sideways market. It produces a lot of whipsaws where the indicator goes from bullish to bearish and back again, quickly rendering it virtually useless.
If you use the parabolic SAR strategy, it is essential to establish a trending market first. The parabolic SAR indicator can be used to give a trading signal that we can take or stand aside. Consequently, your trading strategy should have other variables to indicate whether a buy signal or sell signal is worth putting risk on.
There are few ways in which we can enter a parabolic sell set-up; you can place a buy-stop order at the high of the candlestick that turns SAR, this will force the price to continue trend upward to trigger you into the trade with at least some short-term momentum. You can also enter at the close of the candlestick, which is perfect for the end of day trading (EOD). You can as well set a limit order under the low of the candlestick looking for a short-term pullback after the initial change in trend direction, as shown by the SAR.
The dot feature on the parabolic SAR is vital in the setting of your stop loss locations. You calculate the distance from the entry to the dot, calculate the trading risk and position size to place your stop. Trailing stops allow you to take from the market what it wants to provide you. With a profit target, we are assuming that we know what the market is going to do, where it is going to go. The parabolic SAR indicator makes trailing stop easy. Trailing stops can boost overall returns.
Parabolic stop and reverse
Since the SAR stands for stop and reverse, many traders follow the indicator in that manner. While trading counter-trend can be done, there are specific times to do so, and for most traders, following the longer-term trend is a better way to trade.
Using the moving average as a trend following indicator to show the current trend direction and only taking buy or sell signals from the parabolic SAR, will likely produce better results. As with any technical indicator, moving average relies on the settings you choose as a short-term average will change direction more rapidly than a longer-term average.
Only take signals in the direction determined by the moving average. We do not stop and reverse, we trail using the parabolic SAR but leave a portion of our position at the original stop location. Our stop and remaining position will only move lower for a short and higher for a long, using the new plotted dots.
Double parabolic SAR strategy
A double parabolic SAR strategy is a trend momentum strategy a trader can apply to all trading time frames. The various trading methods you can use this indicator include scalping, day trading, or swing trading to give a good trading outcome. It is also useful for binary options high/low with an expiry time of 5 candles.
The trading rule for double parabolic SAR is that you buy when the two parabolic SAR dots are below the price. Close position when the fast parabolic SAR changes direction, make a profit at the resistance level. You sell when the two parabolic SAR dots are above the price, close position when the fast parabolic SAR changes direction, and make a profit at the support level.
Parabolic SAR formula
An excellent understanding of the calculation of any trading indicator is essential; by so doing, you will be able to find the nuances associated with each indicator.
Parabolic stop and the reverse formula is shown below:
- For uptrend: SARn + 1 = SARn + AF (EP - SARn)
- For downtrend: SARn + 1 = SARn + AF (SARn - EP)
Where;
- SARn is the current period,
- SARn + 1 is the next period value,
- EP = the extreme high or low value in the current trend.
- AF is the acceleration factor./li>
There are three parabolic SAR settings that may be customized, although platforms like MetaTrader may only have 2. The start value is what the acceleration factor is going to start at, and its generally set at 0.02. The increment of the acceleration factor is how much the original value will increase each time a new higher low in the trend is plotted. And the max value prevents the acceleration factor from growing too much.
Conclusion
Parabolic SAR trading assumes that time is the enemy. Thus it is a get in and gets out quick system, this can be good, or it can be deadly for instance, if your position size is small, your gains can be eaten up by transaction costs. Parabolic SAR only works if the market is in a confirmed trend. It is always best to use a wide variety of technical tools to get a confirmation of your trade.
