What is Parabolic SAR Indicator?
Technical analysis is like salt to your meal. If you do not add salt to your food, it would be tasteless and incomplete. But, if you do add, it turns out to be a good meal. Similarly, it is totally good to trade with or without technical analysis. But, the presence of technical analysis makes stock trading more accurate and profitable.
Technical analysis uses chart patterns, candlesticks and technical indicators to guide the traders on deciding entry and exits. The Parabolic SAR indicator is one of the technical indicators useful for this purpose. This indicator is useful for all types of assets traded, ranging from stocks and securities to currency in Forex. This article will guide on what parabolic SAR indicator is, how it works and how it is calculated.
What is a Parabolic SAR Indicator?
In the Parabolic SAR indicator, the SAR indicates stop and reverse orders in which the traders exit the current trade and enter a trade in the opposite direction. Parabolic SAR Indicator is developed by J. Welles Wilder jr., who also introduced the Relative Strength Index (RSI) concept. The Parabolic SAR indicator helps trend-following traders to determine the direction in which the asset traded is moving. Additionally, traders also use this indicator to place stop-loss orders.
The three main functions of this indicator are as follows:
- It sheds a spotlight on current trends
- Warns the traders about a reversal from the prevailing trend
- Indicates the traders on taking entry to or exit from a position.
How Parabolic SAR Works?
On the technical chart of the asset, this indicator can be observed in the form of a series of dots. There will be a price line in the chart. If the series of dots is found above the price line, this reflects a bearish trend. Generally, traders believe this as a sell signal.
In contrast, if the series of dots is below the price line, it is an indication of a bullish trend. Usually, traders prefer to buy in this period.
If a dot is found in the opposite direction, it is an indication of price reversal. For instance, if the series of dots is found above the price line and then a dot found below the price line, it is a signal of a trend reversal from bearish to bullish. Vice versa also holds as a signal for trend reversal from bullish to bearish.
To place stop-loss orders, traders need to adjust the stop-loss with the Parabolic SAR indicator. This means that if a stock price is increasing, the stop-loss amount shall also be increased to match the parabolic SAR and vice versa.
How to calculate SAR Indicator?
The SAR Indicator dots are placed based on their calculation. The inputs needed for calculation are the highest price, lowest price and acceleration factor.
The formula to calculate SAR indicator is as below:
Uptrend parabolic SAR = Prior SAR + Prior Acceleration Factor (Prior Extreme Point- Prior SAR)
Downtrend Parabolic SAR = Prior SAR – Prior Acceleration Factor (Prior SAR – Prior Extreme Point)
The Extreme point is the highest price during an uptrend and the lowest price during a downtrend.
Generally, the Acceleration factor is initially set up at 0.02. This factor tends to increase by 0.02 points whenever EP is recorded, up to a maximum of 0.20. Depending on the trading style and type of asset, traders select the Acceleration Factor.
Once the SAR value is calculated, the dots are plotted above or below the price line indicating the current trend. However, there is a possibility of false signals is another drawback.
To conclude, Parabolic SAR indicators often provide new trade signals to trend traders. However, which signals are suitable and which are not is solely decided by the traders. If used with other complementary indicators, it will benefit the traders with better trade signals. In the absence of an exact trend, using this indicator may worsen the result for the traders and create small losses for them.
Frequently Asked Questions Expand All
Parabolic SAR indicator is beneficial as it helps traders to decide when to buy or hold the security, it also warns traders of a reversal signal and is useful in placing stop-loss orders. A major problem with this indicator is that it only provides signals for uptrend or downtrend. In the absence of an exact trend, it constantly goes over and below the price lines. Thus, it does not provide helpful trade signals in those situations. This indicator is not 100% accurate, therefore it is not independently reliable and there is a possibility of false signals.
This indicator can be read from the series of dots. There will be a price line in the chart. If the series of dots is found above the price line, this reflects a bearish trend. However, if the series of dots are below the price line, it is an indication of a bullish trend.
When the Acceleration factor is taken into consideration is 0.02 or in between 0.018 to 0.021, it is considered the best parabolic SAR setting.