Parabolic SAR in Trading

Traders use various indicators for technical analysis to determine whether to buy or sell stocks. Parabolic SAR is one such indicator that provides valuable insight into the market.

The parabolic SAR (or PSAR) is used by traders who want to verify the direction in which an asset is moving. It can also provide entry and exit points. Keep reading the article to learn more about the indicator and how to use it.

What Is a Parabolic SAR?

So, what is parabolic SAR or PSAR? It’s a technical analysis indicator that was developed by J. Welles Wilder to calculate the direction of a moving asset within a market. The “SAR” stands for stop and reverse system.

The indicator helps with identifying probable reversals in price movements of specific assets. It’s also an indicator used to find entry and exit points.

The creator of an indicator says it works best within trending markets. The basic idea is to establish the direction of a trend by using the SAR and then to use another compatible indicator to measure the strength of this trend.

The graphic depiction of the indicator on the chart looks like a series of dots. If the indicator drops below the current price, it means a bullish signal. If the indicator is above the current price, it is a bearish signal. These signals are used to avoid losses and get profit.

How Parabolic SAR Works?

As mentioned, the indicator looks like a set of dots near the price point. The SAR shows buy signals if these dots go below the price point. Similarly, if the dots go above the price, it means a trader should consider selling stock.

Note: Parabolic SAR is not as reliable within flat or ranging markets. The best way to use the parabolic SAR indicator is to apply it on a steady market. It could produce false signals if the price moves sideways. In that case, traders may experience either small profits or small losses.

The SAR is rather useful for setting stop-loss orders. Set the indicator to match the level of the SAR indicator to get stop-loss results.

Parabolic SAR in Trading

What does It Tell?

The PSAR works as described above, but here are some other potential signals. Traders can use the PSAR dots to establish trailing stop-loss orders. If the price on the financial market is increasing simultaneously with PSAR, then the PSAR signal may be interpreted as a possible exit if long. Similarly, if the price goes down, it’s an indicator to exit the long trade.

What to do if the parabolic SAR indicator moves even if the price doesn’t? It means that the price was rising initially, but then it began moving sideways. That’s why the parabolic SAR indicator is still rising despite the price moving sideways without any increases.

After this occurrence, traders may expect reversal signals, even if the price isn’t going down. The PSAR indicator has to catch up to show real data. This proves that the reversal signal on the indicator doesn’t necessarily mean that the price is also reversing.

Whenever the parabolic SAR moves to the opposite direction of an asset’s price, it means that the new sign was formed. PSAR indicator is highly effective in trending markets because of its peculiarities. On trending markets, when prices move, traders can capture significant gains.

If an asset’s price is range-bound, PSAR will be reversing. As a result, it could lead to several low profits or trade losses. Naturally, traders should combine parabolic indicators with other technical analysis tools to get the most accurate results.

Traders can use the average directional index (ADX), a moving average (MA), etc., to prove the uptrend or downtrend.

Calculating the Parabolic SAR Indicator

The indicator uses the highest and lowest price and the accelerator factor to calculate where the dots will appear. The formula to calculate the parabolic SAR looks as follows:

And as for explanations:

When the trader uses the formula, they get results that create a dot. This dot is set against the asset price movement and is located either below or above the price. These dots enable traders to determine the current price direction.

Parabolic SAR Advantages and Disadvantages

The main advantage of the parabolic SAR is that it provides traders with information about price movement direction. But the technical indicator is only good if it is used in a trending market, then it produces mainly real signals.

Moreover, if a price reversal may occur, the indicator provides a trader with an exit signal to avoid losses. Note: the parabolic SAR is great within trending markets with long rallies and declines.

The problem with the parabolic SAR is that whenever the price starts moving sideways, the indicator may start producing false signals. If there is no current trend within the market, the indicator moves back and forth around the price point. In that case, it’s impossible to forecast the results, and traders may follow false signals. The results are obvious — traders lose profit.

The main takeaway here is that traders shouldn’t rely only on one indicator, especially on a parabolic SAR within a sideways moving market. Make sure to trade with the aid of a SAR only when the trade’s direction is strong, and the trend itself is dominant. Avoid relying on the SAR within markets with absent trends.

With the usage of additional technical analysis tools, such as moving averages, traders can avoid significant losses or miscalculations.

Parabolic SAR Combinations

As mentioned, your best stop-loss tool is the usage of the parabolic SAR in combination with other indicators. Consider using such indicators as ADX, stochastic oscillator, or moving averages.

You can use the moving averages indicator to get more convincing SAR to sell signals when the price of the stock is trading below a long-term moving average. If the price is below the long-term moving average, then it means that stock sellers are controlling the direction and that this recent SAR sell signal could reflect a beginning of another wave lower.

At the same time, if the price is above the moving average, consider it as a buy signal — when dots move from above to below. SAR can still be applied as a stop-loss, but it would be a good idea to take short positions as the longer-term trend is up.

A combination of a parabolic indicator and moving averages may result in a lot of trades. Some traders mention that usage of this combination can capture the entire up move all in one trade. That’s why the indicator is mainly used by active traders to catch the high-momentum move and quickly exit the market.

The parabolic SAR is one of those indicators that is constantly generating signals even if there is no quality trend at the moment. That’s why it’s so important to use other indicators mentioned in the article.

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Carolyn Huntington is an economist, professional trader, and analyst. She made her first big deal in her student years with a profitable investment in Facebook stock. Now the total experience of her trade is 18 years. Over the years of trading, Carolyn has developed its own strategy that allows even those who have never traded on the stock exchange before to earn money. She also creates market forecasts and advises major shareholders, compiles investment portfolios, and teaches how to work with automated advisors.