The Parabolic SAR (Stop-and-Reverse) indicator is a technical indicator that helps traders determine trend direction and possible price reversal points.
It uses the trailing stop and reversal method known as “SAR” to determine entry and exit points. Traders also refer to this indicator as parabolic stop and reversal or PSAR.
How does the indicator work?
The parabolic SAR indicator is displayed on the chart as a series of points located above or below the price of the asset, depending on the direction of price movement. The dot is placed below the price when it is moving up and above the price when it is moving down.
A parabolic indicator generates buy or sell signals when the position of the dots moves from one side of the asset price to the other. For example, a buy signal occurs when the dots move from above the price to below the price, and a sell signal occurs when the dots move from below the price to above the price.
Traders use SAR points to set moving stop losses. For example, if the price rises and the SAR also rises, the SAR can be used as a possible exit from a long position. If the price falls below the SAR, it can also serve as a signal to close the trade.
How do you get optimal results from SAR?
For optimal results, traders often combine the parabolic indicator with other technical indicators such as ADX, MA or trend line to confirm signals and reduce the probability of a losing trade.
Limitations of using Parabolic SAR indicator
Parabolic SAR is always on and constantly generates signals, regardless of whether there is a quality trend or not.
Consequently, many signals may be of low quality because no meaningful trend is observed or developed after the signal.
Reversal signals are also generated, regardless of whether price actually reverses.
This is because a reversal is generated when the SAR catches up with the price due to the acceleration factor in the formula. Thus, a reversal signal can take a trader out of a trade even if the price has not technically reversed.
Parabolic SAR vs. moving average (MA)
SAR and MA both track price and show a trend, but they do so using different formulas.
MA takes the average price over a selected number of periods and then displays it on a chart.
SAR takes the extreme highs and lows and then applies an acceleration factor. These different formulas look different on the chart and give different analytical information and trading signals.
