Parabolic SAR

The Parabolic SAR indicator is a technical indicator created by none other than Welles Wilder, the man who created other top-notch indicators like the Relative Strength Index. Known by its full name as the Parabolic Time/Price System, the shorter name, Parabolic SAR, stands for Parabolic “Stop and Reversal” indicator.

The Parabolic SAR indicator is used best as a signal for exit points. While it can be used for both entry and exit of a trade, the exits are particularly accurate for a technical indicator.

Parabolic SAR Buy & Sell Signals

The Parabolic SAR announces to traders when to buy and sell based on a very simple logic system:

1. Buy signals – Traders should buy when the Parabolic SAR is below the current price, which indicates a bullish trend.
2. Sell signals – Traders should sell a currency pair when the Parabolic SAR is above the current price, which indicates a bearish trend.

The following chart shows the efficacy of the Parabolic SAR as a bullish and bearish technical indicator. There is no strategy required for such a simple indicator:

As you can see, a trader who bought or sold the EUR/USD pair based on the Parabolic SAR would have locked in significant profit totals.

Parabolic SAR Strategy

Various Parabolic SAR strategies have been developed to maximize the efficiency of the Parabolic SAR as a buy and sell indicator. In general, strategies suggest combining the power of the Parabolic SAR’s exit signals with entry signals from another technical indicator.

Here are a few guidelines for building your own Parabolic SAR strategy:

• Add momentum – Above all else, the Parabolic SAR identifies trends. Therefore, traders should consider combining the Parabolic SAR indicator with another technical indicator for momentum trading such as the Relative Strength Index or Moving Average Convergence Divergence.
• Two-Dot Trading – The dots formed by this technical indicator are valuable, but none are as valuable as the first and last dots in each trend. The Parabolic SAR identifies trends; it does not confirm their potential to continue. This point is worth repeating over and over again, because the readings in between the beginning and end of a trend are not at all important to the indicator.

Parabolic SAR Settings

MetaTrader4 offers two Parabolic SAR settings, the “step” and “maximum.” As originally demonstrated by Wilder, the “step” and “maximum” have default settings of .02 and .2, respectively. Wilder originally referred to these two numbers as the Acceleration Factor Increase and the Acceleration Factor Maximum.

Without digging deep into the formula, the Parabolic SAR earns a “step” of .02 up to .20 each time the indicator is long and a new high is reached, or each time the indicator is short and a new low is reached. On reversal, the previous highs and lows in the previous trend, known as extreme values, are used as the baseline for the next trend.

Used with other indicators, the Parabolic SAR is a fantastic indicator to trade. It is recommended that you use it in unison with another indicator, and keep the settings as close to the default setting as possible. A combination of momentum indicators and divergence readings will make this one of the best technical indicators in your arsenal.