Parabolic SAR or acronym from Stop And Reverse is a technical indicator that works well when market trending, Stop, And Reserve itself means stop and reversal, then how to use Parabolic SAR effectively?
If you use Metatrader 4 then you will find this indicator as a trend indicator.
So this is also as one indicator default MT4.
The Parabolic SAR indicator is lagging and this trend-following.
First founded by J Welles Wilder in 1978 in his book entitled “New Concept In Technical Trading Systems”.
You can find the book on Amazon for 49.96 $ if you are want to read hence needs to buy and spent your money.
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What is Parabolic SAR?
Parabolic SAR describes its shape which is similar to a parabolic curve in mathematics.
While SAR itself stands for Stop And Reverse.
The Parabolic SAR indicator is formed from dots that appear at the top or bottom of the price.
Simply put, in an uptrend, the dot SAR will appear at the bottom of the price.
Conversely during the downtrend, the dot SAR will appear at the top of the price.
So it will be useful to identify the beginning of a trend, and also determine the end of the trend because traders must work with the trend.
But along with the development of the times.
There have been many ways to use other Parabolic SAR which has become an improvement using this indicator.
This method also varies from how the SAR itself can be used, as well as the combination of SAR with other indicators to produce a stronger and more accurate trading signal.
This indicator is a trend indicator that gives a signal for the beginning and end of a trend, so its name is Stop And Reverse.
The Parabolic SAR indicator gives a reversal signal on price movements.
From the image above you can see the dot appear above and below the price, the appearance of giving a reversal signal.
Parabolic SAR calculation
The calculation method for Parabolic SAR is very complicated.
But simply put, Parabolic SAR utilizes the highest and lowest levels or points in the market to determine trends in the market.
Then checks whether new points have formed such as Lower Low, Higher Low, Lower High, also Higher High.
These values will be multiplied by certain points such as the acceleration factor for placing the SAR point.
Mathematically, here are some components forming SAR:
- Extreme Point (EP): Determined depending on the current trend.
When Uptrend, the highest price in a period will be used as an EP, while during a downtrend, the lowest price in a period will be used as an EP.
- Significant Point: The highest or lowest market price in a period.
In general terms, the Significant Point is actually the same as Extreme Point.
The difference is, SP is used when the trend ends, while the EP when the trend starting.
- Acceleration Factor (AF): The acceleration factor is a value used in the placement of SAR points.
This value will be applied as a multiplier after Extreme point calculation.
The acceleration factor starts from 0.02 and will continue to increase to 0.2 as the trend goes on.
How to use Parabolic SAR indicator
How to use the Parabolic SAR indicator is very simple, really very simple.
Maybe this indicator is the easiest indicator to use compared to other indicators such as Bollinger band or Fibonacci retracement or moving average crossovers.
- How to use this indicator is if the dot is below the price is a Buy signal
- Conversely, if the dot is above the price then this is a Sell signal, it’s easy, right?
However, this indicator will be powerful when the market is trending, maybe you will encounter a lot of false signals when the market is sideways.
Therefore your understanding of the market trend will affect the success of using this simple indicator.
Because how to use Parabolic SAR effectively is in a high uptrend and long downtrend, you are better off avoiding it when the market is sideways or choppy market.
Parabolic SAR exit
The Parabolic SAR indicator provides a reversal signal, therefore you can also use this indicator to determine your trade exit point.
How to use Parabolic SAR effectively for exit points?
We will give one example on the EURUSD chart with a daily timeframe, so this is for the long term trading plan.
From the EURUSD chart above we can see the downtrend since Apri.
If a trader opens a short position on this pair it might wonder how low the downtrend will continue.
And then in early June, three dots formed at the bottom of the price, this is a signal of a trend reversal.
So the appearance of these three dots shows that the downtrend is over and it’s time to exit Short.
But if you think that the trend will continue to go down and decide to hold on to that trade, then you might erase all of these wins because the pair finally rose back near 1.3500.
If the trader has closed the Short position and made a Buy switch, then they will then wonder where this uptrend will continue.
Then we again see three dots appearing above the price, which is a reversal signal so that traders who have Buy position can close their order when three-dot parabolic SARs appear.
But you can also determine profit targets not based on the appearance of three-dot parabolic SAR.
For example, you use Fibonacci retracement for target profit because parabolic SAR is also lagging so that when exiting by waiting for the three dots the possibility of profit appears less than the maximum.
Parabolic SAR stop loss
Stop-loss is also part of the risk management plan, placing a stop loss based on Parabolic SAR is
- Since a buy position by placing a stop loss several pips below the first dot.
- Since a sell position by placing a stop loss above the first dot.
The advantage of placing a stop loss with these ways that the Stop Loss distance tends not to be too far from the Open position
So that the risk limit is lower, so the opportunity to secure profit is better.
But in addition to placing stop losses in the above manner.
There are some traders who use dot SAR to use trailing stops or modify top loss when strong trends occur.
When traders open buy or sell based on Parabolic SAR.
Sometimes they worry that floating profit will lose when prices turn around unnoticed, remember the market moves dynamically.
In this situation, each time a dot SAR appears the trader will modify the stop loss on the dot.
So that when the trend actually turns around the stop loss will be executed with profit on the final result.
Parabolic SAR best setting
Read also Trading psychology importance
Parabolic SAR as a trigger to determine the entry position.
This entry is a little more complicated than just looking at where SAR points appear, given the number of false signals that can appear when the market is ranging.
How to minimize the fake signal condition? how to use parabolic SAR effectively?
In the book, New Concepts in the Technical Trading System has a detailed explanation
Wilder explained the importance of knowing the major trends of the market before entering the market.
This major trend can be detected by looking at SAR points at a higher time frame.
Or by using other indicators such as Moving Average.
If you already know the magnitude of the trend, Wilder suggests only opening a position in the direction of the magnitude of the trend.
For example, if a long trend is detected uptrend, then just look for opportunities to buy.
In opening the position, Wilder also emphasized to wait until the emergence of 3 dot SAR before entering the market.
Parabolic SAR is a trend following indicator, it will work very well when the market is in a strong trend.
In these strong trend conditions, Parabolic SAR can offer a low level of risk and high returns.
Parabolic SAR can also provide reliable Reversal confirmation.
But in market conditions that are ranging or sideways, Parabolic SAR is relatively weak and often gives false signals.
This makes many beginner traders confused about how to use Parabolic SAR effectively.
The final solution, it’s better not to enter the market when the market is sideways.
Forex needs patience and patience if you want to succeed.
But there are also professional traders out there who have found a way to use the Parabolic Sar indicator in all market conditions.
Whether it’s by combining Parabolic SAR with other indicators.