What is Parabolic SAR?
Parabolic SAR (Stop And Reverse) is an indicator plotted as a continuous series of dots above or below price candles. When the dots sit below price, the market is in an uptrend, and when they sit above price, the market is in a downtrend. This tool is designed mainly for finding trend direction and probable exit points.
How it's calculated
Each SAR point is calculated based on the previous point plus an acceleration factor that gradually increases as the trend continues. This gradual increase causes the dots to move closer to price faster the longer the trend goes on; at the point where price reaches and crosses the SAR dots, the trend is considered reversed and the dots flip to the other side of price.
How to read the chart
The distance between the dots and price also gives useful information; a large distance signals a strong, fast-moving trend, and the dots gradually moving closer to price signals the trend is slowing and a reversal is more likely. Unlike a moving average, which is a continuous line, Parabolic SAR is seen as discrete, individual dots, which makes reading trend direction at a glance easier.
Trading signals
This indicator's simplest signal is the dots flipping from one side of price to the other; the dots moving from above to below price is a bullish signal, and moving from below to above is a bearish signal. Many traders also use Parabolic SAR as a trailing stop, moving their stop loss along with the dots as price moves.
Strengths and limitations
Parabolic SAR works very effectively in markets with a clear, sustained trend and gives clear signals for timely exits. But in ranging, trendless markets, the dots keep flipping from one side of price to the other, producing frequent false signals.
Practical tip
Before relying on Parabolic SAR, first confirm with another tool like a moving average or ADX that the market is actually in a trending phase; using it in a ranging market usually doesn't produce good results.