Parabolic SAR Indicator Explained

Parabolic SAR Indicator in Forex Explained

The Parabolic SAR indicator was developed by Welles Wilder. He introduced this concept in his book “New Concepts on Technical Trading System”. Although this indicator was introduced before the computer times, it got popular and it is widely used. SAR in Forex stands for “Stop and Reverse”. As the name suggests it assess the momentum of price and probability of its reversing.

Parabolic SAR Indicator
Figure 1 – Parabolic SAR Applied on USDCAD

Structure of Parabolic SAR Indicator

On a Forex chart, this indicator consists of dots which are called Stop and Reverse Points (SAR). When the dots are located below the price the trend is bullish and when they are above the price the trend is Bearish. As soon as the dots touch the price, trend is reversed and dots change their placement. When SAR is making a curve it indicates the flat market.

Structure of Parabolic SAR Indicator
Figure 2 – Structure of Parabolic SAR Indicator

Parabolic SAR Calculation

Calculation of Parabolic SAR depends on previous period’s values. Only the Extreme Prices are taken into consideration and accelerating factor is used. SAR is calculated in advance. For example, tomorrow’s SAR values can be calculated based on today’s data. Mathematical Formula for its calculation is:
SARn+1=SARn+a(EP-SARn)
Where,
SAR=Current Period’s Value
SARn=Next Period’s Value
EP= Highest or Lowest Value(Highest in Uptrend and Lowest in Downtrend)
a=Accelerating Factor (By default it is set to 0.02 but can be changed manually)
When a new EP is recorded factor increases 0.02 times. Generally, the maximum value is set to 0.2 preventing it from getting too large. Normally it is 0.01 for stocks and 0.02 for commodities.

There are two anomalies in calculation of SAR:

  • When Trend is Positive: SAR can’t be above the two preceding period’s low. In case it is higher, use the lower of the two instead.
  • When Trend is negative:  SAR can’t be below the preceding two period’s high. In case it is lower, use the higher of the two instead.

Parabolic SAR Signals

It is difficult to explain the calculations of SAR. But it is one of the simplest Forex indicators to be used on the chart. When SAR dots are above the price, it shows a downward trend. And it signals positive trend when the dots are below the price. Trend reversal is identified by SAR when the dots touch the price. These trend reversals can be taken as a major indicator to close the trades.

Parabolic SAR Signals
Figure 3 – Signals Generated by Parabolic SAR

Parabolic SAR Trading Strategy

Parabolic SAR indicator should be used in combination with other Forex trend indicators like Bollinger Bands. When the market is bullish, dots will move upward irrespective of the actual prices. But as soon as the price touches the dots, the trend will reverse and dots will start moving in opposite direction. Trade should be opened just after few dots in opposite trend because the signal generated by this indicator is delayed.

When the trend of the dots is taking a curve, trade should be closed without waiting for the complete trend reversal. Otherwise, one may miss some profits waiting for complete reversal. As all the indicators which are dependent on moving average, SAR also has the probability of giving false signals when the market is flat.

Parabolic SAR Trading Strategy
Figure 4 – Parabolic SAR Trading Strategy

 


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