Parabolic SAR

Introduction of Parabolic SAR

In world of stock trading knowing when you have to make a trade is very important and also when you have to exit but making such decisions will generally be quite the challenge to undertake for people with little to no experience in trading and sometimes it can be so even for those who have thoroughly acquainted themselves with the landscape.

So how can you as a trader navigate this landscape as  a newcomer  knowing that you may face a tough time in making the right trades or decisions?

The answer to that will be and probably always has been picking the right indicator or the right chart and there are all kinds of indicators for you to choose from so you just have to know what you’re looking for.

But if you’re wondering about when to place orders then there might be one indicator that you may want to consider looking into and that is the Parabolic SAR.

What is Parabolic SAR?

The Parabolic SAR indicator was made by J. Welles Wilder and if you don’t know who that is then the RSI indicator should ring a bell in that he’s the person behind that as well which is saying something since the RSI is one of if not the most popular indicator within the landscape as almost anyone who is even remotely familiar with trader may have come across it.

But what is it even made for you might be wondering? Look no further if that is indeed you as we’ll be looking at that below.

Since 2021, Coin-Labs.com has partnered with Bybit and is few of the highest-ranking of affiliate program contracts. Therefore, if you sign up for Bybit through the button above, you will get the most discounted fee benefit and participation in a bonus event offering up to $500.

The Purpose of Parabolic SAR

The Parabolic SAR is used for determining trend direction and possible reversals in price and it uses a method called the trailing stop and reverse which is where the “SAR” comes from all to look for potential entry and exit points basically.

This is why traders refer to this indicator as the Parabolic Stop and Reverse or the PSAR.

You can see the PSAR indicator on the chart as this series of dots which can be either below or above the asset’s price and that depends on the direction you see the price moving towards.

A dot is located below the price if it’s trending upward and above the price whenever its trending downward.

How is Parabolic SAR Calculated?

Whatever trading platform you’re using and if it supports the PSAR indicator then it will automatically do all the calculations for you and you wont need to worry about having to do them yourself but if you’re more of the curious type then here’s how you can go about calculating them yourself.

Parabolic SAR Calculation Steps

There are so many things to monitor when you’re using the PSAR indicator.

One thing that you’ve to constantly keep in mind is that should the SAR be rising initially with the price having a close below that rising SAR value then the trend’s now down and you’ll need to use that falling SAR formula.

But if the price is rising over that falling SAR value then you can shift to the rising formula instead.

So monitor the price for five periods at least or more and record those highs and lows aka the EPs or extreme points.

If you see the price rising then utilize the lowest low of the five periods as the previous or prior PSAR value within the formula but if that price is dropping then just use the highest high of the five periods as that initial prior PSAR value.

Also here are the formulas in case you didn’t know.

RPSAR = Prior PSAR + [Prior AF (Prior EP – Prior PSAR)]

FPSAR = Prior PSAR − [Prior AF (Prior PSAR – Prior EP)]

Acceleration Factor (AF)

You’d also have to use an AF initially of 0.02 and then increase by that same figure 0.02 again for every new extreme rising or falling with the maximum value that you can take the AF to 0.2.

Ideally you’d want to use a spreadsheet with which the low and high prices, the EP, SAR, and the AF may be tracked by a period to period basis.

Key Characteristics of Parabolic SAR

So the key characteristics at least from what can be deduced from the formula would be the RPSAR and the FPSAR which obviously mean the rising and falling PSAR, the AF or acceleration factor and finally the EPs or extreme points.

How to Use Parabolic SAR in Trading

Knowing what the PSAR is all about is good and all but knowing how to trade with it is just as important and this is why we’ll be looking at some of the ways you can go about doing that below. 

Identifying Trend Direction

Probably the most obvious use of this indicator is trend identification or direction and how can you discern that here?

Simple when you see those dots going down you have a bearish trend and you see them going up you have a bullish trend.

One glance of it and identifying trend direction should be pretty self explanatory.

Spotting Reversals

The indicator is made to catch up to price eventually so yes while reversals on it do happen when you see those dots flip but that wouldn’t necessarily entail a reversal within the price.

A PSAR reversal only implies that the indicator and price have crossed and that’s that.

Setting Stop-Loss Levels

Traders can even use those PSAR dots to perform trailing stop loss orders like for example if both the PSAR and the price are rising then you can use the PSAR for a potential exit if you’re going long so if the price goes below that PSAR you can exit that long trade.

Using Parabolic SAR with Other Indicators

Sometimes using one indicator isn’t enough if you really want to amp up the accuracy of your trading and this is no different for the PSAR.

So if you want to complement the  PSAR or improve its accuracy with indicators like the RSI or the MACD then feel free to do so.

Parabolic SAR Strategies for Different Trading Styles

Lets see how the Parabolic SAR relates to some of the popular trading styles you see within the landscape like day, swing and long term trading below.

Day Trading with Parabolic SAR

If you’re a day trader then you’re likely looking for some short term gains with your trading and if you’re using the PSAR indicator then you could start by shortening the time frames to better reflect what you want.

Once done you could use strategies that involve simple trend following or scalping.

Swing Trading with Parabolic SAR

But if it’s swing trading that you find more appealing then you’re likely looking for some medium to long term gains and if that’s the case then you could always adjust the time frames accordingly so that you have a better understanding of how the market has been performing according to your lens.

Strategies that employs crossovers may benefit you more or you could just use it to trade along the trends like the day traders.

Long-Term Investing with Parabolic SAR

But in case you’re in for the long haul then like with day and swing trading increase your time frames to better reflect that so that your view of the market aligns with your requirements.

Advantages and Limitations of Parabolic SAR

Knowing both the pros and cons of any indicator not just the PSAR can go a long way in you making the most out of your trading since you may be better equipped to handle its limitations.

Benefits of Using Parabolic SAR

When it comes to identifying trends and where they’re heading this tool can be a valuable one and also when it comes to setting up stop loss orders as its nature can make it good for knowing when to exit the market.

Limitations of Parabolic SAR

But on the downside there is still the chance of it producing false signals when you see those prices begin to move sideways.

Because of that lack of trends the indicator would instead shit back and forth around that price bar and this is what accounts for those misleading signals.

So if that’s the case and you solely rely on this indicator amidst sideways markets then you may have losing trades on your hands.

Conclusion

The PSAR or Parabolic SAR  indicator is used to determine the direction a stock is heading towards and whether or not one should place stop loss orders.

In trending environments the indicator can produce decent results but it can also generate many false signals or losing trades once the price starts to move sideways.

To help filter those bad signals out you could try trading in the dominant trend’s direction or use some other tools like moving averages to help you with that.