Parabolic SAR

Parabolic SAR is a form of technical analysis​ that can be implemented for a comprehensive trading strategy, when analysing how to trade financial assets, such as indices, shares, commodities and currencies. In this article, we will discuss the pros and cons of the indicator, and look at how and when it should be used.

The parabolic SAR places dots above each price bar if the price is falling, and below each price bar if the price is rising. When the price passes through the dots, there is a potential trend reversal and the dots move to the other side. In this way, its most basic function is to help spot the current trend and signal when that trend direction may be changing.

The parabolic SAR indicator is complex to compute by hand, even though it was introduced in 1978 by J. Welles Wilder Jr. (who also developed the relative strength index), well before the widespread use of computers. The indicator is complex because it accelerates over time.

The calculation shows that the further a trend moves in one direction, the faster the parabolic SAR will accelerate to catch up to it. This is beneficial in that the indicator provides room for the price to move higher (or lower), yet the further the price moves in one direction, the less room the indicator gives it, because a price reversal becomes more likely. Once the price drops below the parabolic SAR, the move may be complete, or at least entering a temporary pullback stage.

The parabolic SAR can be used in several ways in terms of strategies and can be applied to all financial markets​​. Its most basic functions are the following:

As mentioned, the parabolic SAR indicator is available on our Next Generation trading platform. To use the parabolic SAR and to start practising some of the strategies mentioned, register for a live account now. You can also register for a demo account to practise on our parabolic SAR trading system using virtual funds.

You can choose a financial product to trade along the left side of the platform, within the commodities, currencies, indices, shares, and treasuries markets. Its chart will appear on the right, and along the bottom of the chart, there is a tab for “Technicals”. Scroll to the right until you see “Parabolic”. Click to apply it to the chart. The formula will be calculated automatically.

To change the technical indicator settings, hover your cursor over the chart and click on the indicator name in the upper left of the chart. This will bring up the parabolic SAR settings. Adjust as needed.

There are two setting on the indicator: Acceleration Factor (AF) and Maximum Acceleration (MA). By default, these are 0.02 and 0.2. Increasing the Acceleration Factor means the indicator will more closely track the price, leaving less room between the indicator and price. This means more trade signals and reversals will be identified on the chart. Decreasing the Acceleration Factor means that the indicator will move slower, leaving more room between the price and indicator. Fewer reversals will occur.

The Maximum Acceleration works the same in a way, but to a much lesser degree. The MA caps how quickly the indicator can accelerate during a strong price move. Changes in this setting will have less impact than changing the AF.

Short-term traders that want to enter and exit positions quickly may opt for a higher AF, which means that even small reversals will close them out of a trade. Longer-term traders that want to hold their positions may decrease the AF. This will result in the price needing to make bigger moves to cause a reversal, and thus reversals and trade signals will occur less often.

The parabolic SAR is also available for aiding trading strategies on the international platform, MetaTrader 4, which is hosted through our software. The indicator can be adjusted on MT4 in the same way as our own platform, but the names of the variables are different. On MT4, “Step” is the equivalent of the Acceleration Factor, which has a default setting of 0.02. Maximum is the Maximum Acceleration, and it has a similar default value of 0.2. Learn more about the platform by registering for a free MT4 account.

The parabolic SAR provides several basic functions that include providing trend direction, entry and exit signals, and acting as a trailing stop-loss​​. These basic functions can be further enhanced into a strategy by adding some additional rules. The breakout strategy requires isolating the overall visual trend direction. The double parabolic SAR strategy makes this approach more systemic by using the indicator direction on a longer-term timeframe as the overall trend direction. This stipulates in which direction to trade on the lower timeframe.

To complete all these strategies, the risk on each trade must be managed, and you should avoid taking a position size that is too large for your account. By using a stop-loss order, you can prevent capital loss if the price does not move in a favourable direction.

If you wait for a trade signal and candle or price bar to close before entering, then the dots will flip sides and that dot can be used as a stop loss point. However, sometimes the dot will be far away at the start of a trend, or you may not want to wait for a candle close before taking a trade signal. In these cases, you should consider placing a stop-loss below the recent swing low if going long, or above a recent swing high if going short. Two cents or two pips (percentages in point)​​ above the swing or below the swing low is adequate. This final step makes sure that the risk is controlled, while the parabolic SAR takes care of locking in profit if the price moves favourably.