Understanding the Parabolic SAR Indicator
The Parabolic SAR (Stop and Reverse) indicator, developed by J. Wells Wilder, is a cherished tool among traders for discerning trend directions and potential price reversals. This indicator employs a trailing stop and reverse method, universally known as ‘stop and reverse’ or SAR. It is also affectionately referred to as parabolic SAR or PSAR.
Visually Interpreting Parabolic SAR
On a price chart, the parabolic SAR appears as a series of dots, positioned above or below an asset’s price - contingent on the market’s movement. Specifically, a dot below the price signals an upward trend, whereas a dot above indicates a downward trend.
Key Highlights
- The Parabolic SAR identifies trends and reversals, serving as a staple for technical traders.
- Dots represent the SAR on price charts, visual cues for traders.
- A reversal indicator in PSAR denotes a crossing of price and indicator, not necessarily a market reversal.
The Parabolic SAR Formula Explained
The formulas for a rising and falling PSAR differ slightly:
\begin{aligned}
&\text{RPSAR}=\text{Prior PSAR }+\\
&\left[ \text{Prior AF} \left( \text{Prior EP-Prior PSAR} \right) \right] \\
&\text{FPSAR}=\text{Prior PSAR }-\\
&\left[ \text{Prior AF} \left( \text{Prior PSAR-Prior EP} \right) \right] \\
&\textbf{where:}\\
&\text{RPSAR = Rising PSAR}\\
&\text{AF = Acceleration Factor, starting at 0.02, increasing}\\
&\text{by 0.02 up to 0.2, with each new high (rising SAR) }\\
&\text{or low (falling SAR)}\\
&\text{FPSAR = Falling PSAR}\\
&\text{EP = Extreme Point, the highest high (rising SAR)}\\
&\text{or lowest low (falling SAR)}
\end{aligned}
Calculating the Parabolic SAR
Several factors play into calculating the PSAR:
- Track price for a period: Record highs and lows of at least five periods.
- Determine Prior PSAR: For rising price use lowest low; for falling price, use highest high.
- Increment Acceleration Factor (AF): Start at 0.02, incrementing by 0.02 with new extremes, up to 0.2.
- Utilize Technology: Leverage charting software for automatic PSAR calculation, allowing focus on signal interpretation.
What the Parabolic SAR Indicates
The transition of PSAR dots from one position to another generates buy or sell signals:
- Buy Signal: Dots move below the price.
- Sell Signal: Dots move above the price.
Additionally, PSAR dots can serve to set trailing stop loss orders. For instance, during a rising trend where the price and PSAR both ascend, the PSAR can mark an exit point for a long position upon price dropping below it.
Illustrative Scenario
Even if the price remains static, the PSAR will continue moving due to its inherent acceleration, eventually signaling a reversal. Hence, not all reversal signals imply a true market reversal.
Perfect Pairings for the Parabolic SAR
Best results come from integrating PSAR with other technical analysis tools, like:
- Average Directional Index (ADX)
- Moving Averages (MA)
- Trendlines
For instance, confirming a PSAR buy signal with ADX readings exceeding 30 or supporting a rising trendline can offer bolstered trading confidence.
Parabolic SAR vs. Moving Averages
While both track price, they do so differently:
- MA: Tracks average price over selected periods.
- PSAR: Employs extreme highs/lows and acceleration factors.
Parabolic SAR Limitations
The PSAR continuously generates signals, regardless of market trend quality. Thus, signals might be less reliable in non-trending markets, triggering multiple lower-yield trades. Reversal signals purely based on PSAR catching up to the price can prematurely conclude trades.
Disclaimer: This content does not provide financial or investment advice and is meant for informative purposes. Thoroughly assess personal investment goals and risk tolerance before proceeding. Investing carries risks, including the potential loss of principal.
Related Terms: Moving Average, ADX, trendline, sell signal, buy signal.
References
- Jeremy du Plessis. “Definitive Guide to Point and Figure: A Comprehensive Guide to the Theory and Practical Use of the Point and Figure Charting Method”, Pages 394-400. Harriman House Publishing, 2012.
- Jeremy du Plessis. “Definitive Guide to Point and Figure: A Comprehensive Guide to the Theory and Practical Use of the Point and Figure Charting Method”, Pages 394-400. Harriman House Publishing, 2012.
