There are many technical indicators used when trading and each have their own advantages and disadvantages. And one of the most popular indicators is the Parabolic SAR. This article will discuss everything you need to know about Parabolic SAR and how it’s used in trading forex.
Parabolic SAR Definition
The Parabolic Stop and Reverse, or most commonly called Parabolic SAR, is a trend type of technical indicator and was made by J. Welles Wilder, who also created the relative strength index or RSI. Wilder developed this SAR indicator to serve three primary purposes:
- Emphasize current trends
- Predict a reversal in the prevailing trend
- Provide possible exit and entry signals in a reversal
And now, it’s a trend indicator used by traders on any timeframe in various markets. It is used mainly to forecast any possible reversals or continuations in the market. This reversal can be a bullish market becoming a bearish market, or vice versa. On the other hand, Continuations indicate that the prevailing momentum of the market will continue and be maintained.
Wilder recommends that traders find a trend’s direction first using the indicator before using additional indicators to measure how strong the trend is. The parabolic SAR looks like a series of dots when plotted on the charts. And when it appears under the current price, it represents a bullish signal. But when it hovers above the trend, it’s a signal for a bearish pattern which helps in setting up stop losses and even profit targets.
How Does It Work?
Since a set of dots represents the parabolic SAR, they’re interpreted based on their location or placing near the bars. Like we’ve mentioned, above the price signals a potential downward trend and is considered as a “sell” signal. And when the dots are below, it means there’s an upward trend and is regarded as a “buy” signal. The trade signals produced by the fluctuation of the dots’ movement are used by traders to generate profit, especially when the price makes big changes.
This indicator uses the highest price and lowest price as well as the acceleration factor in determining where to put the SAR indicator dot. Traders also need to know how Parabolic SAR is calculated. And there’s a formula for that, which is simple.
Using Parabolic SAR to Trade
Trading with Parabolic SAR is simple. You have to pay attention to the dots. The dots produced by this indicator can be in two colors – red or green. Relating these colors to the signals, when you see green dots, it means you can buy. But if there are red dots, you should sell. However, the signals from the parabolic SAR aren’t always 100% accurate, and it would still depend on how you analyze the market if you want to trade.
But this doesn’t mean you can’t use parabolic SAR to trade. You can, but you should learn how to manage risks. So, if you want to start trading with the parabolic SAR, here are the steps that can help you:
- Conduct research on the market you intend to trade in.
- Perform both fundamental and technical analysis on that market.
- Practice trading using the parabolic SAR with a demo account in your trading platform.
- Identify trends and changes from the signals. Develop potential strategies.
- Create and trade using a live account whenever you’re ready to trade for real.
- Open your position, monitor, and close.
Advantages and Disadvantages of Parabolic SAR
Every technical indicator has its own limitations and benefits to a trader. The same goes for parabolic SAR. To help you understand the indicator better, here are its pros and cons:
- It helps determine what direction the price action will go.
- If used in a strong trending market, it generates good results.
- It’s easy and straightforward to understand.
- It provides essential signals such as exit signals for a potential price reversal when there’s a move against the trend.
- It works best for long rallies or declines in markets.
- It has the possibility of producing false signals, especially when the price actions move sideways.
- If there’s a lack of trend, it will simply move back and forth near the price bar, producing mostly misleading signals.
- Relying only on this indicator when the market is in sideways conditions can result in you losing trades.
Trading using the Parabolic SAR indicator is pretty simple, especially if you understand how it works. Although it’s beneficial, it can also be risky to use.
But, to prevent negative consequences, as a trader, trading in the direction of the dominant trend works the best and avoiding trading when there’s no trend. Moreover, using other technical indicators can also be helpful in preventing risks and losses.