What is Parabolic SAR?
The Parabolic SAR indicator is a price and time based trend-following technical indicator. The abbreviation of SAR stands for “stop and reverse”. One of the most popular trading indicators, Parabolic SAR is one of the most complicated technical analysis tools in terms of underlying calculations.
As long as the asset’s price is in an uptrend, the SAR rises below this price. The idea of using the Parabolic SAR is to signalise a trailing stop. During the uptrend, the SAR will never go down and will only rise, increasing the protected unrealised profits.
After the uptrend, when the asset makes a U-turn and its price goes down below the SAR, the direction changes and the SAR level rises above the price – becoming a trailing stop for the downtrend.
Who invented Parabolic SAR?
Parabolic SAR was developed by J. Welles Wilder, who was an engineer, turned real estate developer, turned technical analyst. Best known all over the world for his works on technical analysis, in the late 1970s, Mr. Wilder developed and introduced the Parabolic SAR along with other technical indicators, including the Average True Range (ATR), Directional Movement (ADX) and Relative Strength Index (RSI).
Why is Parabolic SAR useful for traders?
The popularity of the Parabolic SAR indicator comes out from its easy interpretation. Instead of clouds, ranges or lines, the SAR indicator uses dots, to show all the necessary information on the asset’s price chart.
Dots located underneath the market price in an upward pattern suggest an uptrend. Dots, located above the market price in a downward pattern form a downtrend. These dots are usually considered possible spots to place a trailing stop to limit you risk exposure.
Technical analysis: how to trade with Parabolic SAR?
Parabolic SAR can be applied as a trend following indicator. However, more often traders prefer to use a Parabolic SAR trading strategy alongside other technical indicators.
The Parabolic SAR strategy is usually used to track trends. It is also used as a guide to where you can place your stop-losses to limit you risks and protect the profits, working similarly to the trailing stop adjustments.
You should note that the Parabolic SAR performs best when the markets experience a steady trend. In heavily ranging volatile markets, the Parabolic SAR may fluctuate back and forth, generating faulty trading signals.
Even the SAR founder, J. Welles Wilder recommended to use this indicator together with its peer – the Average Directional Index (ADX) momentum indicator. It may help to get more accurate estimation of the existing trend’s strength.
Moreover, the combination of the ADX + Moving average technical indicators works as an effective solution that may help to improve the signal quality of the Parabolic SAR:
The ADX is a trend referee. If the ADX is above 15, the asset is trending. If the ADX is lower than 15, the asset is in a range. It helps traders to place a trade only when the ADX is above 15 to avoid range markets, which impedes the work of the SAR.
The moving average is used as a directional filter. When the market’s price moves higher than the MA, traders look for buy trades. The SAR here works as a trailing stop.
How to use Parabolic SAR: Sensitivity
The proximity of the SAR dots to the market’s price is a key factor, determining the SAR indicator sensitivity to price changes. The higher the sensitivity, the faster the SAR changes its direction.
This can be either bad, or good, depending on your goals. If you prefer to jump in or out of trades quickly – choose high sensitivity settings. If you’d like to keep your trades going and avoid minor retracements, you’d better choose lower sensitivity.
In Parabolic SAR the rate of change – sensitivity – depends on the acceleration factor (AF). The AF’s settings could be adjusted. This is called a step. By default, the step is equal .02. The maximum step value is .20.
The Parabolic SAR sensitivity is changed by lowering the step. This increases the distance between SAR and price. The Parabolic SAR changes its direction once the price touches its level. Therefore, if SAR is further from the price, the indicator's reversal is less likely.