What is Parabolic SAR & How to Trade With It | CFI JO
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Parabolic SAR in trading

The Parabolic SAR

J. Welles Wilder, the developer of the well-known and commonly used Relative strength index RSI leading indicator developed the parabolic stop and reverse indicator, commonly known as the "Parabolic SAR," or "PSAR" . The PSAR is a trend-following indicator, displayed as a single parabolic line (or dots) underneath the price bars in an uptrend, and above the price bars in a downtrend.

 

The PSAR’s primary functions are:

1- It demonstrates the current trend
2- Points potential entry signals
3- Points potential exit signals

 

The objective behind developing the PSAR is to find a trading system that maximizes profits from trend movements. The PSAR allows the trader to calculate both the beginning of a new trend and its end. The indicator can be used on any tradable instrument and on any timeframe.

PSAR on the chart

Fig (1) Source: developed by the author

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Parabolic SAR calculation:

The PSAR indicator is already available on all price charting software, the calculation is done using algorithms for both uptrend and downtrend accordingly, Traders and analysts don’t need to calculate it themselves, the application will do the job for you however, it is beneficial that the indicator users grasp the concept.

 

- Uptrend: PSAR = Prior PSAR + Prior AF (Prior EP - Prior PSAR)
- Downtrend: PSAR = Prior PSAR - Prior AF (Prior PSAR - Prior EP)

 

Where:

 

- EP = Highest high for an uptrend and lowest low for a downtrend, updated each time a new EP is reached.
- AF = Default of 0.02, increasing by 0.02 each time a new EP is reached, with a maximum of 0.20. The AF factor can be changed on the trading terminal, however, Wilder and most traders using the indicator recommend sticking to the standard value of 0.2

 

Trading using Parabolic SAR ( PSAR):

As mentioned, the PSAR highly performs in trending markets. That said, it is important to first identify the trend. In an uptrend, dots will be under the price action and vice versa in a downtrend. When a change of trend occurs, dots flip from on side of the price action to the other side, “sell and reverse” SAR action.

PSAR dot flipping down

Fig (2) Source: developed by the author

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PSAR flipping above the price action

Fig (3) Source: developed by the author

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The best entry signal to maximize profits is when a change in trend takes place, in other words when the dots flip (the curve breaks) from one side to the other.

 

In fig (2), the trader waits for the close of the green candle under the black dot followed by the formation of the flipped dot under the following candle, that’s when s/he enters a long/bullish trade. Stop loss levels will be at the PSAR levels and traders should update their stop loss levels whenever the PSAR dots move (apply