Pinpoint When a Trend Will “Stop and Reverse”
The Parabolic SAR is a trend-following indicator that is based on time and price. It was introduced in 1978 by one of the pioneers of technical analysis, Wells Wilder. The name of the indicator comes from the parabolas that are formed by a series of plotted dots. SAR stands for “Stop and Reverse”. The indicator is designed to stop and reverse with changing market trends.
Learn more about the Parabolic SAR in this short video:
How does the Parabolic SAR work?
The Parabolic SAR is used to indicate potential reversals in the price of an asset. It displays as a series of dots that will appear either above or below the current price of the asset, depending on the direction of the price trend. If the dots are below the price, it means the market is in an uptrend. If the dots are above the price, the market is in a downtrend.
A reversal is signaled when the dots switch from being below the price to being above the price (ending a downtrend) or from being above the price to being below the price (ending an uptrend). As the price approaches a potential reversal point, the dots will begin to converge. Then, when the price reverses, the dots will start to diverge again. The Parabolic SAR can be used to confirm reversal signals from other indicators or it can be used on its own.
Using the Parabolic SAR to Make Better Trading Decisions
The Parabolic SAR is a useful tool for traders who want to stay in trends for longer periods of time. The indicator can also be used to help traders exit trends early, before a reversal. Some traders also use the distance between the Parabolic SAR point and the price to calculate a trailing stop-loss order. The NinjaTrader platform allows you to attach orders to indicators, which would effectively automate the stop-loss order price based on the Parabolic SAR position on a chart.
While the calculation of the indicator is fairly complex, the results are incredibly instinctive. This makes it a popular complimentary indicator for use in a number of trading systems.
There is not a universal setting for the Parabolic SAR. Thus, it’s recommended to adjust the following inputs based on the targeted instrument characteristics:
- Acceleration: A multiplier that impacts the range of change for the SAR. By default, Acceleration is set to .02.
- Acceleration Max: A user-defined input that dictates the max value of the Acceleration.
- Acceleration Step: Defines the increase each time the most recent extreme (high or low) is achieved. This setting defaults to .02 as well.
Benefits and Drawbacks of the Parabolic SAR
There are a few benefits of using the Parabolic SAR trading indicator:
- It can help you identify potential turning points in the market.
- It can help you stay in a trade longer if the market is still moving in your favor.
- It can help you exit a trade sooner if the market begins to turn against you.
While the Parabolic SAR can be helpful for spotting market reversals, it’s not without its limitations. Here are a few of the Parabolic SAR’s weaknesses to be aware of:
- It is considered a lagging indicator and can be slow to react to price changes.
- It can give false signals in choppy markets.
- It can also produce false signals in a ranging market.
Because of these weaknesses, many traders pair the Parabolic SAR with other trading indicators, such as moving averages, MACD or RSI. It’s generally a good idea to use any indicator to help confirm trading decisions, rather than to produce trade signals.
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