Today’s video is on the popular technical indicator, Parabolic SAR, or Parabolic Stop and Reverse. Originally developed by J. Welles Wilder and described in his book, New Concepts in Technical Trading Systems, this trend following indicator is based on the idea that a strong trend will continue to increase in strength over time, following a parabolic arc. This indicator combines price and time components to determine entry and exit points, confirm trend direction and help establish stop loss values.
The Parabolic SAR is normally shown as a series of dots placed on the chart either above or below a market’s price. In an uptrend, the parabolic arc will be underneath the price and in a downtrend, the parabolic arc will be above the price. If the price trend reverses and breaks above or below the indicator, the indicator will stop and reverse.
Trend Direction and Buy/Sell Signals
The Parabolic SAR is designed to be used in trending markets, and can lead to many false signals in sideways or choppy markets. If a downtrend reverses and starts moving up, the Parabolic SAR is below price and follows price action similarly to a trailing stop. The indicator continues to rise as long as the uptrend remains in place. If price stops rising and reverses below the indicator, a downtrend starts and the Parabolic SAR is above the price, following it similarly to a trailing stop.
When the price closes above the upper Parabolic SAR, a trader could interpret a buy signal. The Parabolic SAR will move from being above price to below price and the trader would cover any existing short positions and reverse direction and buy long.
When the price closes below the lower Parabolic SAR, a trader could interpret a sell signal. The Parabolic SAR will move from being below price to above price and the trader would sell any existing long positions and reverse direction and go short.
Stop Loss Orders
Since the Parabolic SAR follows price action like a trailing stop, it can be a useful tool for traders in determining where to place their stop loss orders. Traders can use the indicator as a guide. The indicator will never decrease in value in an uptrend, therefore protecting profits on long positions as the price increases. The indicator will never rise in value in a downtrend, therefore protecting profits on short positions as the price falls.
