The Parabolic SAR, or Parabolic Stop and Reverse, is a trading system based on trailing stops and is frequently utilized as a technical indicator. As a technical indicator, it serves as a momentum tool to identify possible trend reversals during strong uptrends or downtrends. A reversal can occur when an uptrend shifts to a downtrend or vice versa.

Effectively using the Parabolic SAR enables traders to ascertain the trend direction, identify appropriate entry and exit points, and determine where to set trailing stops. J. Welles Wilder, Jr. introduced the Parabolic SAR in his book, New Concepts in Technical Trading Systems. In this book, Wilder discussed the “Parabolic Time/Price System,” where SAR stands for “Stop and Reverse,” the actual indicator employed in the system.

Wilder designed the Parabolic SAR with three main objectives: to highlight the current trend, to predict a reversal in the existing trend, and to provide potential exit and entry signals during a reversal. The book also covers other indicators such as the Relative Strength Index (RSI), Average True Range (ATR), and Average Directional Movement (ADX).

The Parabolic SAR is an unconventional oscillator. Unlike typical oscillators that use a standardized 0-100 scale, it presents a series of strategically placed “dots.” These dots are positioned either above or below the price, depending on the trend. A dot below the price indicates an upward trend, while a dot above suggests a downward trend. When the dot changes position, it signals that the current trend may be nearing its end, prompting traders to consider closing open positions.

The Parabolic SAR employs a trailing stop level that adjusts as prices fluctuate. This stop level accelerates based on an “Acceleration Factor.” When plotted on a chart, this stop level resembles a parabolic curve, which is the origin of its name. The parabolic function accepts three parameters: the first two control acceleration during upward and downward movements, while the last parameter sets the maximum acceleration.

The Parabolic SAR operates under the assumption that traders are engaging with a trend, anticipating price changes over time. For long positions, the Parabolic SAR will move the stop upward each period, regardless of price movement. Conversely, for short positions, the stop will move downward each period, irrespective of price changes.

The Parabolic SAR can be utilized as either a momentum indicator or a trading system.

Using Parabolic SAR as an Indicator

The Parabolic SAR functions as a “chart overlay” indicator. Unlike other technical indicators like RSI, Stochastic, and MACD, which are displayed as oscillating lines in a separate panel, the Parabolic SAR is overlaid on the price chart as dots. On a price chart, these dots are positioned either above or below the price, depending on its movement direction. A dot below the price signifies that buyers are in control, indicating bullish momentum, while a dot above the price suggests that sellers are in control, indicating bearish momentum.

When the dots switch positions, it signals a potential change in price direction. For instance, if the dots are above the price and then flip below, it suggests that the price may rise. As the price increases, the dots will also rise, initially at a slow pace before accelerating with the trend. The dots will eventually catch up to the price.

Here’s how to interpret the Parabolic SAR as an indicator:

• Price is in an uptrend when the dots are below the price.
• Price is in a downtrend when the dots are above the price.
• A flip of the dots from above to below the price may indicate a potential trend reversal.

Two important considerations when using the Parabolic SAR indicator are:

• The Parabolic SAR is a lagging indicator, meaning it follows price action.
• It is most effective when the price is in a strong trend.

Since the primary function of the Parabolic SAR is to define trend direction, it can be beneficial to combine it with a trend strength indicator, such as the Average Directional Movement Index (ADX). It is advisable to avoid pairing the Parabolic SAR with another momentum indicator, as this may lead to conflicting signals.

The Parabolic SAR is particularly useful during strong trending conditions with long swings. However, it tends to perform poorly in sideways markets, where short price swings do not provide sufficient time to confirm a reversal. In such conditions, the Parabolic SAR may generate numerous false signals, leading to whipsaw trades.

Using Parabolic SAR as a Trading System

The Parabolic SAR trading system utilizes the parabolic level as a “Stop and Reverse” point, calculating the stop for each upcoming period. This system ensures that traders remain in the market at all times. The indicator is represented as a series of dots positioned above or below the price candlesticks or bars, which serve as stop levels.

Traders should take a short position when the dots are above the bars and a long position when the dots are below the bars. When the stop is triggered, the current trade should be closed, and a new trade initiated in the opposite direction. The Parabolic SAR is continuously active, generating signals regardless of whether the price is trending. However, many of these signals may lack quality in the absence of a significant trend.

How to Calculate Parabolic SAR

The Parabolic SAR is calculated using the recent “Extreme Price” (EP) along with an “Acceleration Factor” (AF). The calculation varies depending on whether it is applied during an uptrend or a downtrend.

For an uptrend:

PSAR = Prior PSAR + Prior AF (Prior EP - Prior PSAR)

For a downtrend:

PSAR = Prior PSAR - Prior AF (Prior PSAR - Prior EP)

In this calculation, EP refers to the highest high for an uptrend and the lowest low for a downtrend, updated each time a new EP is reached. The AF used by Wilder is set at 0.02, increasing by 0.02 each time a new EP is reached, with a maximum of 0.20. This means the stop moves 2 percent of the distance between EP and the original stop. Each time the EP changes, the AF increases by 0.02 until it reaches the maximum acceleration of 0.2.

Most trading platforms allow you to easily overlay the Parabolic SAR on any price chart with just a click.

The Parabolic SAR is a technical indicator that traders use to forecast whether a prevailing trend will continue or reverse. The indicator is based on parabolic lines represented by a series of dots. Dots below the price indicate a bullish trend, while dots above signal a bearish trend. A dot flipping above the price may suggest a bearish reversal, while a dot flipping below may indicate a bullish reversal.

It is advisable to avoid using the Parabolic SAR in sideways or consolidating markets, as it tends to generate numerous false signals.