Parabolic SAR Indicator Forex Indicator
Parabolic SAR Indicator
Parabolic SAR (Stop and
Reverse) is an indicator developed by J. Willes Wilder to discover and exploit
profitable trends in all kinds of markets. It is a popular tool among technical
traders, and a straightforward and as a simple mechanism for analyzing the
markets, it offers some unique advantages over other tools.
Below we have a chart
of the EURUSD pair depicting the Parabolic SAR in action. We observe that the
indicator was able to capture many small reversals with remarkable accuracy.
And in those cases where it failed, we see that the thrust of the market action
was strong enough to place it into a correct configuration, thereby minimizing
the potential losses of a faulty trade.
Calculation of the
Parabolic SAR
Parabolic SAR is
calculated by a recursive formula which ties the prices of one period to
another through simple arithmetics.
SAR of Today = SAR of
Yesterday + a (EP- SAR of Yesterday)
Or
SAR of Tomorrow = SAR
of Today + a(EP-SAR of Today)
EP is the maximum
recorded during the time period in consideration. If during each period of
analysis a new record is broken, the EP will be updated accordingly, and the
SAR value will change.
"a"
represents the acceleration factor. It is set at 0.02 in the beginning, and
reset each time a new EP is achieved. This is to ensure that the indicator's
value will come closer to the EP value every time a new record is broken, but
the maximum value for the EP is usually set at 0.2 in order to prevent it from
becoming too large and distorting the analytical picture. Due to the higher
volatility of the forex market, traders prefer to give an initial value of 0.01
to the acceleration factor on the basis that frequent fluctuations, leaps and
bounces in the price action do not justify attaching a lot of significance to
arbitrary price highs.
Once the SAR value is
calculated one of two courses will be taken in order to derive the signal from
the indicator. If tomorrow's SAR remains within today's or yesterday's price
range, the indicator is set at the lowest price during that time period. For
example, if the SAR is slightly above yesterday's opening lowest price, or
close to, but below, yesterday's high, the indicator will be set at today's
lowest price.
If on the other hand,
tomorrow's SAR value is within tomorrow's price range, the indicator will
switch sides. If it is below the price action, it will move to the upside, and
if it was on the upside it will come below, signifying a trend switch.
Trading with Parabolic
SAR
Parabolic SAR is
generally regarded as a trend indicator, since other types of markets tend to
generate false signals leading to whipsaws and fake breakouts. The best way of
trading the Parabolic SAR is to first gauge the direction of the market by
using simple tools like trend lines, moving averages, or tools like the average
true range, before using Parabolic SAR to trade the shorter-term fluctuations
that can be exploited within a longer term framework.
When it is drawn on a
chart, the Parabolic SAR will indicate a bullish market if it remains below the
price, or supports it, and when it is above the same it is regarded to be
suppressing the prices, indicating bearish conditions. Not only is it possible
to regard this phenomenon as a signal for the opening of a position, but it
also makes sense to use the Parabolic SAR as a stop or take profit level in
each trade. For instance, when the price action is bearish, and we have a sell
order, one can choose to exit the position when the price action approaches the
SAR level by a predetermined number of pips. When the market action is bullish
on the other hand, we can use the Parabolic SAR as a support level, and when
the price gets too close to it, we can liquidate the trade. It is also possible
to use a time-stop while trading with this indicator. In this case, there is no
necessity of a market reversal. Instead we determine a timeframe during which
the trade will be kept active, but when that period is out, we'll liquidate it
even if the Parabolic SAR indicator is indicating positive conditions. This
course of action is justified on the basis that in a strongly trending market
where this indicator is most useful, lack of progress can be a sign of
approaching reversal.
Conclusion
This indicator is most useful in a trending
market. It is best to use it in combination with other indicators that
establish the general direction of the trend at a higher level, while trading
short-term volatility with the SAR. The advantages of this technical tool are
its simplicity, clarity of signals, ease of interpretation, and tendency to
generate concrete points of action during a trending market. These same
strengths are also the weaknesses of the indicator. It is sometimes the case
that the solid signals of the SAR indicator lack any practical basis. To avoid
such conditions, we suggest that you use the SAR indicator with oscillators
that signal emerging divergence/convergence scenarios, so that the common
problem of whipsaws are reduced in frequency. Ultimately, of course, our best
guide should always be money management and prudence in trading, beyond any
single technical indicator