The Parabolic SAR (stop and reverse indicator) is a trading indicator used in markets with a strong trend to determine buy and sell signals for your chosen trading instrument. The “stop and reverse” feature indicates that the Parabolic SAR is an indicator that was designed to enable a trader to be either long or short – always in the market.
- The Parabolic Sar works by plotting dots above and below price which determines your buy and sell signals.
- The dots rise or fall with price according the indicator setting called acceleration.
- The white dots on this chart of crude oil futures, are called a parabola.
- When the Parabolic Sar plots below price, consider the market to be in an uptrend.
- When the Parabolic Sar is plotting over price, the market is in a downtrend.
Flipping of the Dots
- The Parabolic Sar has flipped to under the candlesticks on this chart (bullish mode) and that would signal an exit from any short position and be a buy signal
- This is the candlestick that flipped the indicator to the bottom and this would be your trade entry candlestick
- This candlestick has signaled an exit from your long position and a sell signal has been triggered (bearish mode)
Like all technical indicators, the Parabolic Sar is a lagging indicator as it requires a calculation of price in order to plot on the chart.
Calculation: SARn+1= SARn + α(EP – SARn)
- SARn is the current period
- SARn+1 is the next period value
- EP equals the extreme high or low value in the current trend
- “A” is the acceleration factor There are 3 settings for the Parabolic Sar that you can customize although some platforms like Metatrader may only have 2.
- The start value is where the acceleration factor will start at – generally 0.02
- The acceleration factor is how much the original value will increase each time a new high/low in the trend is plotted
- The max value prevents the acceleration factor from increasing too large.
The great thing about this indicator is the plotted dots are also stop loss locations. In the inset picture, you can see price has flipped to the bottom which is a buy signal.
Few ways to enter a Parabolic SAR setup:
- Place a buy stop order at the high of the candlestick that turned the SAR. This will force price to continue moving up to trigger you into the trade with, at least, short term momentum.
- You can enter at the close of the candlestick which is perfect for end of day trading (EOD).
- You can set a limit order under the low of the candlestick looking for a short-term pullback after the initial change in trend direction as shown by the Parabolic SAR.
Using the Parabolic SAR As A Trailing Stop
You can use the dot feature of the Parabolic SAR for stop loss locations: Calculate the distance from your entry to the dot, calculate your trading risk and position size, and place your stop loss in that location.
The longer term trend is a better way to trade. Using a moving average as a trend following indicator to show the current trend direction and only taking buy and sell signals from the Parabolic SAR, will likely produce better results.
- The buy or sell signal candlestick must be above the moving average for longs and below for sell signals.
- Only take signals in the direction determined by the moving average – we do not stop and reverse.
- We trail using the Parabolic SAR but leave a portion of our position at the original stop location.
- Our stop on our remaining position will only move lower for a short and higher for a long, using the new plotted dot.