Parabolic SAR

What Is Parabolic SAR?

The Parabolic SAR is a technical analysis indicator that helps traders determine the direction of an asset's price movement. It uses a series of dots to indicate potential trend reversals and acts as a trailing stop-loss. Its purpose is to help traders stay in a trend until it shows signs of reversing.

The Parabolic SAR is important in trending markets, but it should not be relied on solely for making trading decisions. Thus, it is wise to consider other indicators and market factors before making any trading decisions. The indicator is represented by a series of dots plotted on a chart to indicate potential trend reversals.

• Parabolic SAR is a popular technical analysis indicator that uses a trailing stop and reverse method to help traders determine the direction of a trend and potential trend reversals.
• It can be useful in identifying trend direction, potential reversals, and setting stop-loss orders, but it should not be relied on solely for making trading decisions.
• Traders should consider using it with other technical analysis indicators and market analysis to confirm signals and make informed trading decisions.
• The accuracy of it can vary depending on the market conditions and the time frame used. Therefore, as with any technical analysis tool, it is important to consider other factors before making trading decisions.

Parabolic SAR Explained

Parabolic SAR (Stop and Reverse) is a technical analysis indicator traders use to determine the direction of a particular asset's price movement. Its calculation is based on the asset's price and time and tends to rise gradually. When the asset's price is above the dots, the trend is considered bullish, while a downtrend is indicated when the dots are below the asset's price.

The dots of the SAR indicator act as a trailing stop-loss, and traders use them to set their stop-loss orders. The indicator is particularly useful in trending markets, as it helps traders to stay in a trend until it shows signs of reversing.

It is important to note that while it is a useful tool, it should not be relied on solely for making trading decisions. Instead, traders should consider other indicators and market factors before making trading decisions.

Formula

The formula for calculating the Parabolic SAR is as follows:

SARn+1 = SARn + AF x (EP - SARn)

Where:

• SARn+1 is the new value of the Parabolic SAR for the next period.
• SARn is the current value of the Parabolic SAR for the current period.
• AF is the acceleration factor, which starts at 0.02 and increases by 0.02 each time a new high is established, up to a maximum of 0.2
• EP is the extreme point, which is the highest high of the current uptrend or the lowest low of the current downtrend, depending on the direction of the trend.

If the current trend is an uptrend, the formula for calculating the EP would be:

• EP = the highest high of the current uptrend

If the current trend is a downtrend, the formula for calculating the EP would be:

• EP = the lowest low of the current downtrend

Examples

Let us have a look at the examples to understand the concept better.

Example #1

Suppose a trader is analyzing the price of a stock and notices that the Parabolic SAR dots are below the stock price, indicating a downtrend. The trader could use this information to set a stop-loss order above the dots to limit potential losses. However, the Parabolic SAR dots gradually move lower as the stock price declines, signaling a strong downtrend. Therefore, the trader may decide to hold onto the stock until its dots move above the stock price, indicating a potential trend reversal, and consider selling the stock to take profits or avoid further losses.

Example #2

Let's assume the stock's current price is $50, and the previous Parabolic SAR value was $48. Therefore, the acceleration factor is set to 0.02, and the maximum acceleration factor is 0.2.

Calculate the current Parabolic SAR value.

• Start by calculating the initial SAR value. It's the lowest low of the first two periods. Let's assume the stock's low for the first two periods was $45, so the initial SAR value is $45.
• Next, calculate the acceleration factor. It starts at 0.02 and increases by 0.02 each time a new high is established.
• Calculate the SAR value for the current period. The SAR value for the current period is the previous SAR value plus the acceleration factor multiplied by the difference between the previous SAR value and the previous period's low. SAR value = $48 + 0.02 x ($48 - $45) = $48.60

Plot the SAR value on the chart.

• If the current SAR value is below the current price, plot the SAR value below the price.
• If the current SAR value is above the current price, plot the SAR value above the price.

Repeat the process for the next period.

• Use the previous period's SAR value as the starting SAR value for the next period.
• If a new high is established, increase the acceleration factor by 0.02.
• Calculate the new SAR value using the formula in Step 1.
• Plot the new SAR value on the chart.

Chart

 Let us look at the gold price chart below to fully understand the concept.

As one can observe, the above chart includes the Parabolic SAR indicator. Traders can use it to analyze the direction of the trend and potential trend reversals. When the Parabolic SAR dots are below the price, it indicates a bullish trend, and when they are above the price, it signals a bearish trend. Traders may also use the dots to set their buy, sell, and stop-loss orders accordingly.

If people wish to look at more such charts to improve their knowledge with regard to this indicator, they can visit the TradingView website.

How To Use?

Here are some ways to use the Parabolic SAR in trading:

1. First, determine the trend direction: Traders can use the Parabolic SAR to determine whether the current trend is bullish or bearish. When the Parabolic SAR is below the price, it is considered a bullish trend; when it is above the price, it is a bearish trend.
2. Identify potential trend reversals: The Parabolic SAR can also help traders identify potential trend reversals. When the dots switch sides, it could signal a trend reversal, and traders may consider taking profits or changing their positions.
3. Set stop-loss orders: The SAR can act as a trailing stop-loss. Therefore, traders can set their stop-loss orders just below the Parabolic SAR dots during an uptrend or just above them during a downtrend to limit potential losses.
4. Confirm other indicators: Traders can use it with other technical analysis indicators to confirm signals. For example, if the SAR shows a bearish trend, but the Moving Average Convergence Divergence (MACD) indicates a bullish trend, traders may want to wait for additional confirmation before trading.

Frequently Asked Questions (FAQs)

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