Developed by J. Wells Wilder, the Parabolic SAR is used to determine the best times to exit or enter a market and is based on the Stop and Reverse (SAR) method. It is calculated using both time and price. This results in a series of trailing stops that look like a parabola when charted.

An intersection of the price with the parabola is taken as a signal to reverse the current trading position (that is, go from long to short). The indicator is always in the market - so once a parabola is reached, a new parabola is plotted in the opposite direction. NOTE: Each stop is displayed on the day in which it is in effect.

The stops are recalculated each day (or for every time period you're using) and become closer as the trend progresses. Once a trade is initiated, the indicator allows a few days for a market reaction to the change in trend. As the trend gets underway, the stop progresses with the market - slowly at first, then in more rapid increments in the direction the trade was initiated. The stop may sometimes stand still as the trend consolidates. If the trend fails to continue, the moving stop will reverse the position and a new time period begins.

This indicator is also referred to as the Parabolic Indicator, Parabolic System or SAR.

• Parabolic SAR Charts

  Interpretation

  The Parabolic SAR generates good exit points from trades that are entered using another indicator. Use the Parabolic SAR to enter the market in the direction of the trend. Use the stops on reversal to exit the market and stand aside until the trend is identified (either resumption of the previous trend or confirmation of a new trend) and another Parabolic SAR signal to enter appears.

  • If the price moves above the SAR, this can be considered a buy signal (go or stay long).
  • If the price moves below the SAR, this can be considered a sell signal (go short).

  Advantages and Disadvantages

  The greatest value of the Parabolic SAR is as a method of setting stops. The Parabolic SAR overcomes the problem of losing profits due to lagging exit signals with most trend-following indicators. It solves the price lag problem by increasing stops whenever a new high or low is reached. It is also different to most trend-following indicators in that it is a function of time as well as price. The result of this time factor is that the price must continue to move in the direction of the trend or the trade will be stopped out.

  With trend-following indicators, the whipsaws can be a big problem in a range market, so it is a good idea to use the Parabolic SAR in conjunction with other indicators (such as one of the Directional Movement indicators).

  Tips

  • If another indicator shows that the market is trending then enter on Parabolic SAR signals compatible with the trend. Therefore, only use Parabolic SAR signals in the direction of the trend to open positions.
  • Exit on Parabolic SAR signals incompatible with the trend. If another indicator shows that the market is de-trending, use Parabolic SAR signals to temporarily exit the market.

  Reference

  • Wilder, J. W. (1978). New Concepts in Technical Trading Systems. Trend Research.