Parabolic SAR (Stop and Reverse)
A complete guide to using the Parabolic SAR indicator for identifying trend direction and setting dynamic stop-loss levels.
The Parabolic SAR (Stop and Reverse) is a popular technical indicator used to determine the direction of a security's momentum and to provide entry and exit points. Developed by J. Welles Wilder Jr., the creator of the Relative Strength Index (RSI), the Parabolic SAR appears on a chart as a series of dots either above or below the price. These dots follow the price action, creating a parabolic curve that helps traders identify when a trend might be ending and reversing.
What is the Parabolic SAR?
The Parabolic SAR is a time and price-based technical indicator that is primarily used to identify the direction of a trend and to provide signals for potential trend reversals. When the dots are below the price, it suggests an uptrend, and when the dots are above the price, it indicates a downtrend. The 'SAR' in its name stands for 'Stop and Reverse,' highlighting its utility in setting trailing stop-loss orders and identifying when it's time to exit a trade and potentially enter a new one in the opposite direction.
The Parabolic SAR is designed to always be in the market, either in a long or short position, making it particularly useful for active traders.
The Parabolic SAR Formula and Calculation
The calculation of the Parabolic SAR involves an acceleration factor that increases as the trend extends over time. The formulas for the rising and falling SAR are as follows:
Where:
- AF (Acceleration Factor): This is a variable that starts at a predefined value (typically 0.02) and increases by that same value each time a new extreme point is reached, up to a maximum value (usually 0.20).
- EP (Extreme Point): This is the highest high of the current uptrend or the lowest low of the current downtrend.
How to Read and Interpret the Parabolic SAR
Interpreting the Parabolic SAR is straightforward:
- Dots Below the Price: When the SAR dots are below the price candles, it signals a bullish trend. This suggests that buying pressure is strong, and the price is likely to continue rising.
- Dots Above the Price: When the SAR dots are above the price candles, it indicates a bearish trend. This suggests that selling pressure is dominant, and the price is likely to continue falling.
- Dot Flips: A flip in the position of the dots from below to above the price is a sell signal, indicating a potential trend reversal to the downside. Conversely, a flip from above to below the price is a buy signal, suggesting a potential reversal to the upside.
The distance between the SAR dots and the price can indicate the strength of the trend. A wider gap suggests a strong trend, while a narrowing gap may signal that the trend is weakening.
Trading with the Parabolic SAR: Strategies and Examples
Trend Following and Trailing Stops
Combining with Other Indicators
Advantages and Limitations of the Parabolic SAR
Advantages
- Provides Clear Signals: The Parabolic SAR gives clear, easy-to-interpret buy and sell signals.
- Effective in Trending Markets: It performs exceptionally well in markets with a clear and sustained trend.
- Built-in Stop-Loss Mechanism: It provides a dynamic and systematic way to set trailing stop-losses.
Limitations
- Whipsaws in Sideways Markets: In ranging or non-trending markets, the Parabolic SAR is prone to generating frequent false signals (whipsaws).
- Can Be Overly Sensitive: The constant 'stop and reverse' nature can lead to premature exits from trades that are still viable.
It is crucial to assess the market environment before relying on the Parabolic SAR. It is not recommended for use in isolation, especially in choppy markets.
Adjusting Parabolic SAR Settings
The standard settings for the Parabolic SAR are an acceleration factor of 0.02 and a maximum acceleration factor of 0.20. However, these can be adjusted to change the indicator's sensitivity:
- Increasing the Acceleration Factor: A higher acceleration factor will make the indicator more sensitive to price changes, resulting in more frequent reversals. This can be useful for short-term trading but may also lead to more whipsaws.
- Decreasing the Acceleration Factor: A lower acceleration factor will make the indicator less sensitive, resulting in fewer signals. This can help to filter out noise but may also lead to delayed entries and exits.
Key Takeaways
The Parabolic SAR is a trend-following indicator that provides clear buy and sell signals.
Dots below the price indicate an uptrend, while dots above the price signal a downtrend.
It is particularly useful for setting trailing stop-losses.
The indicator is most effective in trending markets and can produce false signals in sideways markets.
The sensitivity of the Parabolic SAR can be adjusted by changing the acceleration factor.
Parabolic SAR (Stop and Reverse)
A complete guide to using the Parabolic SAR indicator for identifying trend direction and setting dynamic stop-loss levels.
The Parabolic SAR (Stop and Reverse) is a popular technical indicator used to determine the direction of a security's momentum and to provide entry and exit points. Developed by J. Welles Wilder Jr., the creator of the Relative Strength Index (RSI), the Parabolic SAR appears on a chart as a series of dots either above or below the price. These dots follow the price action, creating a parabolic curve that helps traders identify when a trend might be ending and reversing.
Table of Contents
What is the Parabolic SAR?
The Parabolic SAR is a time and price-based technical indicator that is primarily used to identify the direction of a trend and to provide signals for potential trend reversals. When the dots are below the price, it suggests an uptrend, and when the dots are above the price, it indicates a downtrend. The 'SAR' in its name stands for 'Stop and Reverse,' highlighting its utility in setting trailing stop-loss orders and identifying when it's time to exit a trade and potentially enter a new one in the opposite direction.
The Parabolic SAR is designed to always be in the market, either in a long or short position, making it particularly useful for active traders.
The Parabolic SAR Formula and Calculation
The calculation of the Parabolic SAR involves an acceleration factor that increases as the trend extends over time. The formulas for the rising and falling SAR are as follows:
Where:
- AF (Acceleration Factor): This is a variable that starts at a predefined value (typically 0.02) and increases by that same value each time a new extreme point is reached, up to a maximum value (usually 0.20).
- EP (Extreme Point): This is the highest high of the current uptrend or the lowest low of the current downtrend.
How to Read and Interpret the Parabolic SAR
Interpreting the Parabolic SAR is straightforward:
- Dots Below the Price: When the SAR dots are below the price candles, it signals a bullish trend. This suggests that buying pressure is strong, and the price is likely to continue rising.
- Dots Above the Price: When the SAR dots are above the price candles, it indicates a bearish trend. This suggests that selling pressure is dominant, and the price is likely to continue falling.
- Dot Flips: A flip in the position of the dots from below to above the price is a sell signal, indicating a potential trend reversal to the downside. Conversely, a flip from above to below the price is a buy signal, suggesting a potential reversal to the upside.
The distance between the SAR dots and the price can indicate the strength of the trend. A wider gap suggests a strong trend, while a narrowing gap may signal that the trend is weakening.
Trading with the Parabolic SAR: Strategies and Examples
Trend Following and Trailing Stops
Combining with Other Indicators
Advantages and Limitations of the Parabolic SAR
Advantages
- Provides Clear Signals: The Parabolic SAR gives clear, easy-to-interpret buy and sell signals.
- Effective in Trending Markets: It performs exceptionally well in markets with a clear and sustained trend.
- Built-in Stop-Loss Mechanism: It provides a dynamic and systematic way to set trailing stop-losses.
Limitations
- Whipsaws in Sideways Markets: In ranging or non-trending markets, the Parabolic SAR is prone to generating frequent false signals (whipsaws).
- Can Be Overly Sensitive: The constant 'stop and reverse' nature can lead to premature exits from trades that are still viable.
It is crucial to assess the market environment before relying on the Parabolic SAR. It is not recommended for use in isolation, especially in choppy markets.
Adjusting Parabolic SAR Settings
The standard settings for the Parabolic SAR are an acceleration factor of 0.02 and a maximum acceleration factor of 0.20. However, these can be adjusted to change the indicator's sensitivity:
- Increasing the Acceleration Factor: A higher acceleration factor will make the indicator more sensitive to price changes, resulting in more frequent reversals. This can be useful for short-term trading but may also lead to more whipsaws.
- Decreasing the Acceleration Factor: A lower acceleration factor will make the indicator less sensitive, resulting in fewer signals. This can help to filter out noise but may also lead to delayed entries and exits.
Key Takeaways
The Parabolic SAR is a trend-following indicator that provides clear buy and sell signals.
Dots below the price indicate an uptrend, while dots above the price signal a downtrend.
It is particularly useful for setting trailing stop-losses.
The indicator is most effective in trending markets and can produce false signals in sideways markets.
The sensitivity of the Parabolic SAR can be adjusted by changing the acceleration factor.
Related Terms
Apply This Knowledge
Ready to put Parabolic SAR (Stop and Reverse) into practice? Use our tools to analyze your portfolio and explore market opportunities.
This content is also available on our main website for public access.