i. Developed by J. Welles Wilder Jr. and the indicator is also known as Stop and Reverse System.
ii. It is a trend following indicator.
iii. When dots are above price it is bearish and when it is below it is bullish.
What is Parabolic SAR?
It can be used to know the direction of the price and also to set stop loss and targets.
This indicator mainly consists of a mathematical formula that is applied to the historical price data of the currency.
The formula is a tad bit complex hence in this post I will not dive into the calculation part of it, as it will not make much of a difference.
Traders can determine the direction of the trend as well as spot any potential reversals in the price of the asset with the help of this tool.
This indicator which when applied on the price chart of any currency appears as a series of dots situated either above the price bars or candlesticks or even below them.
The Parabolic SAR indicator is available on all charting platforms and can be applied by searching for the indicator in the Indicators section.
You can alter the settings of the indicator but I would suggest that you stick with the default settings. You can change the size or color of the indicator as per your requirements though.
Trading the Parabolic SAR
The bullish signal means that the bulls are in the control and that the momentum is likely to stay upwards. The bearish signal means that bears are in control and that the momentum is likely to remain downwards.
The indicator not only shows the prevailing momentum in the price of the currency but also gives indications in case of any price reversal.
Whenever there is a flip in the dots, traders must expect a reversal in the trend and must be ready to trade the same.
For instance, if the dots were below the price bars and then a dot formed above the price bar, it is a bearish forex signal, which indicates that the trend is no more bullish and that the bears are taking control.
Whereas if the dots were above the price bars and a dot is formed below, it indicates that the bulls taking control and the trend is turning bullish.
Traders can also use the Parabolic SAR to place their stop losses. When in a trade, traders can place their stop loss at the price level at which the dots of the indicator is situated.
Since this indicator is a trend indicator, traders can trail their stop loss as the dots keep moving in direction of the trend which allows them to ride the trend and capitalize on it.
Limitations of Parabolic SAR
This indicator is based on the idea that time is the enemy. It means that if a trade doesn’t generate more profits as time passes by, it should be exited.
This indicator works best in trending market conditions i.e. when there is a long rally or when there is a steep decline, while it gives many false signals during a sideways or a ranging market.
Even Wilder, who developed this indicator, suggested that traders can first determine the overall trend using this indicator, they can then use alternative indicators for entries or to measure the strength of the trend.
Combining it with other indicators
Parabolic SAR is an indicator and will have its limitations. As I mentioned above, this indicator should not be used standalone but should be combined with other indicators to get better results.
Here are some strategies involving the Parabolic SAR indicator and some other reliable indicators.
1. Parabolic SAR and Moving Averages
The Moving Averages indicator needs no introduction and it is one of the most if not the most widely used indicators. It is very simple to use and you can combine Moving Averages with any form of analysis and get good signals to trade.
Combining Moving Averages with Parabolic SAR will be beneficial as the former will tell you about the market conditions and the latter will give the trade signals.
Moving Averages tell us about trends, if the price is above the indicator then it is bullish and if it is below the indicator then it is bearish.
So to trade the Parabolic SAR and Moving Averages setup you first have to see if the price is above the Moving Average or below.
If it is above, then you will only take long trades and if it is below then you will only take short trades.
When the price is above the Moving Average, then the buy signal will be when Parabolic SAR dots start getting formed below the price. Sell signal is when the Parabolic SAR dots start getting formed above the price.
You can also combine Moving Average crossovers with Parabolic SAR. On bullish crossovers only long trades and on bearish crossovers only short trades.
In both instances stop losses can be placed above or below recent swing high or low and you should exit the trade whenever the Parabolic SAR flips against us.
2. Parabolic SAR and Stochastic oscillator
Stochastic is another commonly used indicator. It is an oscillator which means that its values move between two extremes, 0 and 100. It indicates whether the price is overbought or oversold.
Using Parabolic SAR and Stochastic is very easy. You have to look for the Stochastic reading and the Parabolic SAR is used for trade signals.
If the Stochastic value is in the overbought region then only short trades are to be taken and if it is oversold, then only long trades.
Once you see that the Stochastic indicator is showing overbought, then you have to look for a Parabolic SAR flip and the dots should start forming above the candlesticks.
If the Stochastic indicator is showing oversold, then long trades will be taken when the Parabolic SAR dots start forming below the candlesticks.
Stop loss will again be placed below the recent swing low in long trades and above the recent swing high in short trades. Targets could be according to RRR but I would suggest that you hold and exit only the Parabolic SAR dots flip against us.
What do you think about this indicator?
I am sure that you have heard about the Parabolic SAR indicator and might have used it also, do you think it is a good indicator? Do let me know in the comments section.
Share this blog post with others and let them also know about this indicator and maybe they could use it and profit too.
Feel free to shoot questions or queries in the comments section and I will get back to it at the earliest.