Parabolic SAR is the technical indicator developed by Welles Wilder for analyzing Forex trend movements. The first time it was announced in a famous book named "New Concepts in Technical Trading Systems" published in 1976. SAR stands for as "stop and reverse". Parabolic SAR is one of a few indicators that signalize about closing of positions. In many respects, Parabolic SAR is similar to a moving average with the only difference that Parabolic SAR can change its own position against price. Under ascending tendency, the indicator is drawn below the prices (candles, bars), under descending tendency it is put above prices. When price crosses Parabolic SAR line, reversal of the indicator takes place.
SAR (i) = ACCELERATION * (HIGH (i - 1) - SAR (i - 1)) + SAR (i - 1)
SAR (i) = ACCELERATION * (LOW (i - 1) - SAR (i - 1)) - SAR (i - 1)
SAR (i) - Parabolic value for period i;
SAR (i - 1) — Parabolic SAR at previous bar;
HIGH (i — 1)— the highest price for previous period;
LOW (i - 1)— lowest price for previous period;
ACCELERATION — acceleration factor.
It can be noted from the formulas that starting points for indicator's “pivoting” is High and Low price for previous period. Acceleration factor depends on two parameters: step and High that can be set in the indicator's preferences in trading terminal MetaTrader 4.
Pic. 1 - Parabolic SAR parameters
Where i - is the number of periods after beginning of calculation.
In point of fact, acceleration formula is rather more complicated, but we will not go deep into it so not to get confused. It is important to understand the following: the higher value of step is, the more sensible the indicator becomes towards price changes. High value will regulate parabolic along movement of price. For example, if High value is 0,3 (30%) it means that the maximum possible approach of Parabolic SAR to price is 30% from the last movement.
W. Wilder recommends using 0.02 step and High on the level of 0.2. Such parameters are the most well-defined for the most part of market situations. Practicing traders can always turn to demo account for trying out other parameters and find the most suitable for their trading system. Besides, an author states that primary defining of tendency is the best option, because parabolic operates the best way on trend markets, which is about 30% of time according to statistics.
Trading signals of Parabolic SAR
Signal for sending order will be when price line crosses line of Parabolic SAR. Signal for purchase occurs when price gets above Parabolic line and signal for sale is when price is under Parabolic.
Pic. 2 – Parabolic SAR (Step- 0,02; High – 0,06)
It is rather often when indicator is used as the level for establishing protective Stops, which can be lifted manually if required (manual trailing stop). In this case present value of SAR will act as stop level for current bar. For the next bar it will be another level.
Parabolic SAR surely stands out against other indicators. Its advantage is an excellent work under directed trend as well as the possibility of easy and effective placement of Stop Orders. Disadvantages include delays of the indicator, plenty of false signals on faded trends and in phase of flat movement. Therefore it is strongly recommended to start from defining prevailing tendency and find required parameters for a certain trading instrument and time-frame.