The Parabolic SAR Indicator (PSAR) is a popular indicator that is mainly used by traders to forecast short-term momentum. The indicator was developed by the famous technician known as Welles Wilder. The calculation of this indicator is rather complex and goes beyond the scope of how it is practically used in trading.
Parabolic SAR stands for a Parabolic Time/Price; SAR itself means stop and reverse system. SAR indicator is often used for recalculations of stop loss (trailing SL).
Parabolic SAR consists of the “dots” placed beyond or above the price on the main chart. Often positioning of the PSAR dots is used by traders to generate transaction signals depending on where these dots are regarding the asset’s price. When dots appear below the price, the trend is considered to remain upward tendency. Similarly, a dot placed above the prices illustrates that the bears are in control and that the momentum is likely to remain downward
Welles Wilder introduced the Parabolic Time/Price System in his book, New Concepts in Technical Trading Systems in 1978. Also, this book contained Average Directional Movement Concept (ADX), Relative Strength Index (RSI) and the Average True Range (ATR) indicators. Despite being developed before the computer age, Wilder’s indicators have stood the test of time and remain extremely popular.
For long positions:
SAR (i) = SAR (i – 1) + ACCELERATION * (HIGH (i – 1) – SAR (i – 1))
For short positions:
SAR (i) = SAR (i – 1) + ACCELERATION * (LOW (i – 1) – SAR (i – 1))
SAR (i – 1) — value of Parabolic SAR on the previous bar;
ACCELERATION — acceleration factor;
HIGH (i – 1) — maximal price for the previous period;
LOW (i – 1) — minimal price for the previous period.
The indicator value increases if the price of the current bar is higher than previous and vice versa. The acceleration factor (ACCELERATION) will double at the same time, which would cause Parabolic SAR and the price to come together. In other words, the faster the price grows or sinks, the faster the indicator approaches the price.
Usage in trading
Due to the simplicity of interpretation of this indicator, it is rarely used by itself. Nevertheless, to integrate readings of PSAR into more complex strategies, it is important to know two fundamental principles of trading with it.
The moment, when the SAR dots are shifting position regarding the price, considered as a trade signal. For instance, the situation when PSAR dots are shifting position from above the price to below the price should be viewed as a Buy Signal. Likewise, shifting from below to above underly Sell Signal.
As we see, Indicator gives good signals on the trending market and false signals on the flat market.
Also used to provide exit points. The signals are similar to Open Points, only in a reverse manner. Long positions should be closed when the price jumps below the PSAR line; short positions should be closed when the price goes above the PSAR line. It means that trader should trace the movement of Parabolic SAR and hold open positions while Indicator confirms trade direction. There is a common technique to place Stop Loss below or above SAR dots, regarding the trade direction.
The chart shows two Long trades (Buy positions), opened by Entry Points Signal and closed by Exit Points. It is clear, that such strategy wiдl give many false signals on the stagnating market.