Parabolic SAR is one of several popular indicator in forex trading, although it could also be used in other trading assets.

The technical indicators we have talked about so far have always been about how to catch emerging trend. However, actually it's equally important to know where a certain trend ends. After all, what's important for forex traders is to know the right time to enter and exit the market. In this regard, Parabolic SAR excels as it uses a series of dots to pinpoint potential reversals in the market price direction on the chart.

 

Parabolic SAR Basics

Parabolic SAR, also known as simply SAR, is short for Parabolic Stop And Reverse. Developed by J Welles Wilder, Jr in the 70s, the lagging indicator became well-known and turned into one of several popular indicator in forex trading although it could also be used in other assets' trading.

SAR is calculated using mathematical formula:

SARn+1 = SARn + α (EP - SARn)

Where SARn+1 refers to SAR value for the next period, SARn is SAR value for the current period, EP (Extreme Point) is new highest or lowest price recorded, and α is acceleration factor that will move up 0.02 every time a new EP is recorded (traders can customize this parameter). In some trading platform, you can find this indicator on the list of ready-to-use technical indicators, and can simply place it on the chart by clicking the option and customize (or not) the parameters.

Basic usage of Parabolic SAR is more or less similar to Moving Average, that is to monitor the ongoing trend. It is just that because Parabolic SAR is constructed as a series of dots instead of lines, it is relatively easier to interpret rather than Moving Averages. Let's see Parabolic SAR in the following chart:

Parabolic
We can see on the chart that when the trend is bullish, Parabolic SAR moves under the candlesticks. While when the trend is bearish, Parabolic SAR moves over the candlesticks. The further the Parabolic SAR located from the lowest point or from the highest point, the stronger the trend. Therefore, we can place sell order when the dots appear over the candlestick, or buy order when the dots appear below the candlesticks. This is how we can determine the position we can take by monitoring Parabolic SAR. Afterward, get out of the trade when a series of dots appear in the opposite side. Easy, isn't it!?

 

Parabolic SAR As Stop Loss

Just like its name suggests, apart from indicating trend, Parabolic SAR can also be used to determine stop loss. We all know just how important Stop Loss is to manage risks in forex trading. Well, with Parabolic SAR we can determine Stop Loss in the beginning od the trend. Let's see the following chart:

Parabolic
If the market is as shown in the chart, then let's say we take short position with TP at 134.12 (red horizontal line), then we can place stop loss at SAR dot in the beginning of the trend as shown by the green line. In the chart above, I used Parabolic SAR with setting 0.06|0.26. However, we can use the default setting as well or other modifications, whichever is more convenient for your trading strategy. 

 

Parabolic SAR And MACD

In practice, it is better to combine Parabolic SAR with other indicators that can indicate momentum or oscillator, such as MACD, Stochastic, or RSI. This is because just like other lagging indicators, Parabolic SAR tend to beed in responding to price changes.

To use Parabolic SAR along with MACD, apply the two indicators on the chart of your favorite pair. Set both of them at default setting, that is MACD (12, 26, 9) and Parabolic SAR (step 0.02 and maximum 0.2). Afterward, monitor them carefully. If at the same time there is MACD cross and Parabolic SAR changes, place buy stop order around the highest price of the candlestick, or a sell stop order around the lowest price of the candlestick. It is said that the strategy could work well if the market is trending.

At a glance, Parabolic SAR provides an easy application of technical indicator. However, it is not flawless. As mentioned before, it can beed in responding to price changes and it is better to be used when the market is trending. This is because there are two major weakness of Parabolic SAR. First, SAR system works based on assumption that the trend changes every time a stop has been hit, therefore makes it useless when there are retracements or continuing trend. Second, trend speeds may be different from time to time, which may make SAR parameters too slow at some time and too fast in another.