What Is the Parabolic SAR Indicator?
Let me explain the Parabolic SAR indicator to you directly. I know you're here for the facts, so here's what it is: developed by J. Wells Wilder, this tool helps traders like you determine trend direction and spot potential price reversals. It uses a trailing stop and reverse method called 'SAR,' which stands for stop and reverse, to pinpoint suitable entry and exit points. You might hear it called the parabolic stop and reverse, parabolic SAR, or simply PSAR.
On your chart, the indicator shows up as a series of dots, placed either above or below the asset's price based on the trend direction. When the price is trending upward, the dot goes below it; when downward, above it. That's the straightforward visual cue you get.
Key Takeaways
- The parabolic SAR (stop and reverse) indicator is used by technical traders to spot trends and reversals.
- The indicator utilizes a system of dots superimposed onto a price chart.
- A reversal occurs when these dots flip, but a reversal signal in the SAR does not necessarily mean a reversal in the price. A PSAR reversal only means that the price and indicator have crossed.
The Formula for the Parabolic SAR Indicator
You need to know that a rising PSAR has a slightly different formula than a falling one. Here's the breakdown: RPSAR = Prior PSAR + [Prior AF (Prior EP - Prior PSAR)], and FPSAR = Prior PSAR - [Prior AF (Prior PSAR - Prior EP)]. In these, RPSAR is rising PSAR, AF is the acceleration factor starting at 0.02 and increasing by 0.02 up to a maximum of 0.2 each time the extreme point hits a new low (for falling SAR) or high (for rising SAR). FPSAR is falling PSAR, and EP is the extreme point—the lowest low in a downtrend (falling SAR) or highest high in an uptrend (rising SAR). That's the math you or your software will use.
How to Calculate the Parabolic SAR Indicator
Calculating this involves tracking several elements, so pay attention. Remember, if the SAR is rising and the price closes below that rising SAR value, the trend switches to down, and you use the falling SAR formula. Conversely, if the price rises above a falling SAR, switch to the rising formula.
Start by monitoring the price for at least five periods or more, noting the highs and lows as EPs. If the price is rising, take the lowest low from those periods as your initial prior PSAR in the formula. If falling, use the highest high. Begin with an AF of 0.02, increasing it by 0.02 for each new extreme high (rising) or low (falling), maxing at 0.2. I recommend using a spreadsheet to track high and low prices, SAR, EP, and AF period by period.
Important note: charting software does this calculation automatically, so you mainly need to focus on interpreting the signals.
What Does the Parabolic SAR Indicator Tell You?
This indicator gives you buy or sell signals when the dots shift from one side of the asset's price to the other. For instance, dots moving from above to below the price signal a buy, while the opposite signals a sell.
You can also use PSAR dots for setting trailing stop loss orders. If the price is rising and so is the PSAR, use the PSAR as your exit point if you're long—exit if the price drops below it.
Keep in mind, the PSAR keeps moving even if the price doesn't. If the price starts sideways after rising, the PSAR will continue upward and eventually generate a reversal signal, even without a price drop. It just needs to catch up to the price. So, a reversal on the indicator doesn't always mean the price is actually reversing.
The indicator produces a new signal every time it flips sides, keeping you always positioned in the market, which suits active traders. It shines in trending markets with big moves for significant gains. In range-bound markets, though, it reverses constantly, leading to many low-profit or losing trades.
For better results, combine it with other indicators like the average directional index (ADX), a moving average (MA), or a trendline to confirm if the market is trending. You might, for example, confirm a PSAR buy with an ADX above 30 and a bounce on a long-term rising trendline.
The Parabolic SAR vs. a Moving Average (MA)
Both the PSAR and moving averages track price and show trends, but they use different approaches. A moving average averages prices over a set number of periods and plots that. The PSAR, however, focuses on extreme highs and lows with an acceleration factor. These differences mean they look distinct on charts and provide varying insights and signals.
Limitations of Using the Parabolic SAR Indicator
The PSAR is always active, generating signals whether there's a real trend or not, so many could be low quality without a significant trend developing. Reversal signals come eventually, even if the price doesn't reverse, because the acceleration factor lets the SAR catch up to the price. This might exit you from a trade prematurely, without a true reversal.
Finally, note that this information isn't tax, investment, or financial advice. It's presented without considering your specific objectives, risk tolerance, or circumstances, and may not suit all investors. Investing carries risk, including potential loss of principal.
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