Good day to each and every one. In today’s modern age, one
of the areas that sees greater attention from individuals is the realm of
financial markets. Financial markets have participants from almost all around
the world. While these markets promise high profits, they also entail certain
risks. In Stock and Forex markets, to manage risks and participate in
successful trading, it is necessary to possess knowledge of technical and
fundamental analysis. Technical analysis covers various topics, one of which is
technical indicators. Unlike humans, indicators are objective technical tools,
free from emotions. This aspect provides us with a remarkable advantage in
avoiding making emotional decisions while trading in financial markets. In this
article, we will take a closer look at the “Parabolic SAR” indicator.
What is
Parabolic SAR?
Parabolic
SAR (Stop and Reverse) is one of the trend indicators used in technical
analysis, and it was developed by John Welles Wilder Jr. Welles Wilder is also
the creator of many other popular indicators in technical analysis, such as Relative Strength Index (RSI) and Average True Range (ATR). Parabolic SAR was
introduced by Wilder in his book titled “New Concepts in Technical Trading
Systems”, published in 1978. This book provides detailed information about
various technical analysis tools, including how the Parabolic SAR indicator
works. The term “SAR” stands for “Stop and Reverse”. Parabolic SAR is widely
used in financial markets, particularly for tracking trends and identifying
reversal points. It’s a useful tool for detecting moments when the current
trend might change direction, and it can be used to reverse positions
accordingly. The Parabolic SAR indicator is usually displayed on a price chart
as dots or lines. These dots appear above or below the price, and their
movement depends on the direction of the price trend.
Calculating Parabolic SAR
Understanding how the indicator works before trading can be
beneficial in the long run. Parabolic SAR calculations vary based on whether
the trend is in an uptrend or a downtrend.
- If the trend is in an uptrend: PSAR = Previous PSAR + Previous AF (Previous EP - Previous PSAR)
- If the trend is in a downtrend: PSAR = Previous PSAR - Previous AF (Previous PSAR - Previous EP)
AF (Acceleration Factor). Another factor used during
calculations is the acceleration factor (AF). This factor determines the
indicator’s rate of acceleration. Initially, it’s often set at 0.02, and it
increases by this factor in each step. For example, increasing by 0.02 in each
step.
EP (Extreme Point). Extreme Point (EP) is the highest
or lowest price point determined according to the trend’s direction. In an
uptrend, the highest price point (High) is used. In a downtrend, the lowest
price point (Low) is used.
Parabolic SAR calculations can be complex and require a lot
of computation. Trading platforms usually handle these calculations
automatically and show them on charts. When the trend changes direction,
Parabolic SAR resets its calculations and starts fresh to match the new trend.
Trading with Parabolic SAR
The Parabolic SAR indicator provides direct buy and sell
signals. When the trend is upward, green or blue dots appear below the price,
and when the trend is downward, red or orange dots appear above the price. This
way, if the dots are above the price chart, we place a Sell order. If
the dots are below the price chart, we place a Buy order. It is important to note that
this works better in trending markets. However, it might not be as effective in
sideways markets and can give false signals.
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| Using the Parabolic SAR in the EUR/GBP chart |
When Parabolic SAR dots get closer to the chart, it signals a possible reversal or pullback. When the trend changes direction, the dots quickly move to the other side. This provides us with information about whether the current trend is continuing or reversing. The Parabolic SAR indicator also considers the distance between the dots, not just their placement. At the beginning of a new trend, Parabolic SAR dots start to approach each other. This convergence indicates increasing momentum and the emergence of a trend. As the trend gains strength, the dots move farther apart. On the other hand, as momentum slows and price movement becomes steadier, Parabolic SAR dots once again start to draw closer to each other. Another use of Parabolic SAR is to determine stop-loss levels. Especially in long positions, when prices are falling and the points cross above, it’s a signal to consider closing the position. If we have a short position in the market, Parabolic SAR points should be above the price. If the Parabolic SAR points move below the price, it reflects a probable trend reversal or upward price movement. In this case, we might think about protecting our position or setting a stop-loss level.
Be
mindful of the fact that, the Forex market can be very profitable, but it’s also sensitive to
events and news. This means that prices can react very quickly. Sometimes,
indicators can give false signals. Like any indicator, Parabolic SAR can
sometimes be misleading when used alone. Therefore, it’s usually better to use
it alongside other technical analysis tools and indicators to confirm and
achieve better results. Success in trading & best regards!