Developed by J. Welles Wilder Jr. | SAR = Stop and Reverse
About Parabolic SAR
Parabolic SAR (Stop and Reverse) is a very popular indicator used to determine the short-term momentum of a trading instrument.
Developed by J. Welles Wilder Jr. This indicator when applied to a trading strategy would allow a trader to determine where a stop order must be placed.
This indicator uses a trailing stop and reverse methodology, hence called “SAR”, to identify suitable entry and exit points. Traders refer to this indicator as parabolic stop and reverse or parabolic SAR.
Parabolic SAR is shown on charts as a sequence of dots, appearing above or below prices, depending on the trend direction. A dot would show up below the price when the trend is up, and would show up above the price when the trend is down. Reversal happens when the dot position with respect to prices changes. When prices fall below these parabolic dots, then the dots will now appear above the prices. This indicates a downtrend is under way and vice versa.
A dot below the price indicates an up move in prices. When the dot flips from below to above the price, it indicates change in direction.
A dot above the price indicates a down move in prices. When the dot flips from above to below the price, it indicates change in direction.
Chart below shows an example of bullish signals generated by Parabolic SAR in both trending and sideways market. Blue arrow on the left hand side (1) shows the dot flipped from above to below the price. Open BUY position at the open of the next bar/candle, with stop loss level set at or below the parabolic dot. Using parabolic SAR we can maximize profit potential by staying in the trade for as long as possible. Green arrows show that stop loss levels can be adjusted as parabolic dots move with prices. For as long as the dot has not flipped side, BUY position would be kept open. As can be seen the trade made a nice profit.
On the right hand side we could see 4 blue arrows giving out bullish signals. Price was moving sideways. Same as before, open BUY positions at the open of next bar/candle. But this time, all these trades either got stopped out or liquidated because the dots flipped side and not making profits.
Chart below shows an example of bearish signals generated by Parabolic SAR in both trending and sideways market. When market is moving sideways, parabolic SAR do not work so well just like in the bullish signal example (see the 4 Red arrows in the middle). All these trades either got stopped out or liquidated because the dots flipped side and not making profits.
The last red arrow on the chart (2), also gave out bearish signal. SELL at the open of next bar/candle with stop loss at or above the parabolic dots. Green arrows show that stop loss levels can be adjusted as parabolic dots move with prices. For as long as the dot has not flipped side, SELL position would be kept open. As can be seen the trade made a nice profit.
Always remember that Parabolic SAR is best used in a trending market with long rallies and not ideal for a sideways market. It is also best to combine it with other technical indicators.