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Introduction To The Parabolic SAR Indicator
Parabolic SAR is a very popular indicator for day trading. It helps traders gauge which direction an asset is moving. It also tells us what are the suitable entry and exit points. Technical analysis J. Welles Wilder created this indicator and many others.
How The Parabolic SAR Indicator Works
This indicator is also called the Parabolic Stop and Reverse indicator. The “stop” refers to the stop-loss level. This indicator helps traders identify stop-loss points to control risks. Traders should learn to effectively control the potential risks, and not miss the opportunity to earn more money.
But this is no easy feat. If the stop loss level is set too high, minor price swings may lead to positions being closed. Hence, traders miss the opportunity to earn more profits. If the stop loss level is set too low, traders bear greater risks. Therefore, learning to use the SAR can help traders better set the stop loss level.
The SAR not only tells traders where to enter/exit a position but also opportunities to carry out reverse trading. For instance, when the indicator signals a reverse trend, traders can open a new one in the opposite direction.
How To Use The Parabolic SAR Indicator
As the name of the indicator suggests, the Parabolic SAR indicator identifies where trends stop and reverse based on price parabola. On the chart, the Parabolic SAR is represented by a series of dots placed either above or below the price bars.
The indicator is very easy to read: a dot below the price is considered as a bullish signal. And a dot above the price indicates a bearish move. If the dots flip, that the momentum may reverse, and that’s where an enter or exit point appears.
In the above example, SAR dots switch from below the price to above it gives out a selling signal. Traders can wait for several full SAR signals to close before entering a position to avoid misleading signals. The dot flipping below the price is a take profit point.
How To Calculate The Parabolic SAR Indicator
The Parabolic SAR uses the highest and lowest price and the acceleration factor to determine where the SAR indicator dot will be displayed. The formula for the Parabolic SAR is as follows:
SAR = Prior SAR + AF x (Prior EP – Prior SAR)
SAR = Prior SAR – AF x (Prior SAR – Prior EP)
EP is the extreme point in a trend (the highest point reached by a price during an uptrend or the lowest price reached during a downtrend).
AF refers to an acceleration factor. It is initially set to a value of 0.02 (it is increased by 0.02 each time the EP is recorded, with a maximum of 0.20).
Pros And Cons Of The Parabolic
Although the indicator is considered a lagging indicator, it is one of the most popular tools for day trading.
This indicator is most useful during trending markets. But it is not reliable during periods of consolidation. Besides, this indicator is sensitive to price swings. So highly volatile market may give out misleading signals. Creator Wilder suggested traders use the Average Directional Index along with it. The former can help identify strong trends. For instance, when the ADX indicator identifies a strong price trend, use the Parabolic SAR to determine the direction.