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What is the Parabolic SAR indicator and how is trading done with it

How to trade with the Parabolic SAR Indicator? Parabolic SAR Indicator: Overview, definition, formula, calculation and trading strategies.

Good day to each and every one. In today’s modern age, one of the areas that sees greater attention from individuals is the realm of financial markets. Financial markets have participants from almost all around the world. While these markets promise high profits, they also entail certain risks. In Stock and Forex markets, to manage risks and participate in successful trading, it is necessary to possess knowledge of technical and fundamental analysis. Technical analysis covers various topics, one of which is technical indicators. Unlike humans, indicators are objective technical tools, free from emotions. This aspect provides us with a remarkable advantage in avoiding making emotional decisions while trading in financial markets. In this article, we will take a closer look at the “Parabolic SAR” indicator.

What is Parabolic SAR?

Parabolic SAR (Stop and Reverse) is one of the trend indicators used in technical analysis, and it was developed by John Welles Wilder Jr. Welles Wilder is also the creator of many other popular indicators in technical analysis, such as Relative Strength Index (RSI) and Average True Range (ATR). Parabolic SAR was introduced by Wilder in his book titled “New Concepts in Technical Trading Systems”, published in 1978. This book provides detailed information about various technical analysis tools, including how the Parabolic SAR indicator works. The term “SAR” stands for “Stop and Reverse”. Parabolic SAR is widely used in financial markets, particularly for tracking trends and identifying reversal points. It’s a useful tool for detecting moments when the current trend might change direction, and it can be used to reverse positions accordingly. The Parabolic SAR indicator is usually displayed on a price chart as dots or lines. These dots appear above or below the price, and their movement depends on the direction of the price trend.

Calculating Parabolic SAR

Understanding how the indicator works before trading can be beneficial in the long run. Parabolic SAR calculations vary based on whether the trend is in an uptrend or a downtrend.

  • If the trend is in an uptrend: PSAR = Previous PSAR + Previous AF (Previous EP - Previous PSAR)
  • If the trend is in a downtrend: PSAR = Previous PSAR - Previous AF (Previous PSAR - Previous EP)

AF (Acceleration Factor). Another factor used during calculations is the acceleration factor (AF). This factor determines the indicator’s rate of acceleration. Initially, it’s often set at 0.02, and it increases by this factor in each step. For example, increasing by 0.02 in each step.

EP (Extreme Point). Extreme Point (EP) is the highest or lowest price point determined according to the trend’s direction. In an uptrend, the highest price point (High) is used. In a downtrend, the lowest price point (Low) is used.

Parabolic SAR calculations can be complex and require a lot of computation. Trading platforms usually handle these calculations automatically and show them on charts. When the trend changes direction, Parabolic SAR resets its calculations and starts fresh to match the new trend.

Trading with Parabolic SAR

The Parabolic SAR indicator provides direct buy and sell signals. When the trend is upward, green or blue dots appear below the price, and when the trend is downward, red or orange dots appear above the price. This way, if the dots are above the price chart, we place a Sell order. If the dots are below the price chart, we place a Buy order. It is important to note that this works better in trending markets. However, it might not be as effective in sideways markets and can give false signals.

Entering BUY and Sell orders in the EUR/GBP pair with the Parabolic SAR Indicator.
Using the Parabolic SAR in the EUR/GBP chart

When Parabolic SAR dots get closer to the chart, it signals a possible reversal or pullback. When the trend changes direction, the dots quickly move to the other side. This provides us with information about whether the current trend is continuing or reversing. The Parabolic SAR indicator also considers the distance between the dots, not just their placement. At the beginning of a new trend, Parabolic SAR dots start to approach each other. This convergence indicates increasing momentum and the emergence of a trend. As the trend gains strength, the dots move farther apart. On the other hand, as momentum slows and price movement becomes steadier, Parabolic SAR dots once again start to draw closer to each other. Another use of Parabolic SAR is to determine stop-loss levels. Especially in long positions, when prices are falling and the points cross above, it’s a signal to consider closing the position. If we have a short position in the market, Parabolic SAR points should be above the price. If the Parabolic SAR points move below the price, it reflects a probable trend reversal or upward price movement. In this case, we might think about protecting our position or setting a stop-loss level.

Be mindful of the fact that, the Forex market can be very profitable, but it’s also sensitive to events and news. This means that prices can react very quickly. Sometimes, indicators can give false signals. Like any indicator, Parabolic SAR can sometimes be misleading when used alone. Therefore, it’s usually better to use it alongside other technical analysis tools and indicators to confirm and achieve better results. Success in trading & best regards!

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