The Parabolic SAR is a momentum indicator calculated from the rate of price change and plotted on a chart. They can use the indicator to identify when the price may reverse, but it does not indicate what direction. The indicator only displays a buy signal when the sharp price rise slows and starts to decline, which signals that profit-taking has begun among traders. Traders who use this charting technique will then sell their position in anticipation of further downward movement.
What is Parabolic?
The is a popular indicator used to determine the strength of a security's price movement over time. The S in the name represents the speed at which this price movement occurs, with P representing profit and the average. If you're trying to find out how short-term traders use this indicator, please check out our article on simple arbitrage trading parabolic curve displays an increasing pattern of change and peak height as it transitions into a declining pattern in the long term. Today, this indicator keeps track of the price's value during a trading period. Parabolic SAR automatically adjusts its parameters to changes in a security's price. As a result, the indicator can remain valuable and applicable throughout all market conditions. However, this also allows traders to be on the lookout for future price movements and current prices because it can provide an early indication of whether or not security will continue moving up or down.
How Parabolic SAR works
The most significant criticism of this indicator is that it's hard to understand how it works. However, the indicator is quite simple, and you don't need to be an expert to analyze the data because all you need to do is look at a chart alongside a line. Once you do, you'll notice that this line only tracks one variable: price. The line will move up and down as the price changes, which usually happens whenever a change in market conditions occurs. However, this is why you'll see a parabolic curve form, and it will look like a rising and then falling curve. The main difference between the Parabolic and simple moving average is that the latter doesn't adjust itself to price changes and can sometimes cause it to stray away from the middle, where there should be no bias. Therefore, traders often use a combination of both indicators to create an accurate picture of how the market is moving.
Other Indicators that Complement Parabolic
SAR can be used on its own. Still, it is often used alongside other indicators to give traders a clearer picture of how information related to security is moving. In addition, traders often add trend lines on top of their parabolic curves to give them a better idea of the price trend. Two popular indicators commonly used include the SMA and Fibonacci retracement levels.
Variations in SAR
While the indicator is based on the speed at which a security's price moves, there are several variations you should know about. If you're looking for a way to improve your games, you should study this indicator and see if they can use it to improve your strategy. Some of these variations include:
How to Calculate the SAR Indicator
The indicator is calculated through the use of a formula. It's also important to know that the calculations required are different for every security, so make sure to find out if you're looking at a stock exchange or commodity before you put it into action.
The formula of the Parabolic is as follows:
Uptrend Parabolic = Prior SAR + Prior AF (Prior EP – Prior SAR)
Downtrend Parabolic = Prior SAR – Prior AF (Prior SAR – Prior EP)
EP is the extreme point in a trend (the highest point reached by a price during an uptrend or the lowest price reached during a downtrend).
AF is the acceleration factor initially set to a value of 0.02 (increased by 0.02 each time the EP is recorded, with a maximum of 0.20). Traders can choose the acceleration factor depending on the trading style or instrument being traded).
How to use the SAR indicator
One of the most common things traders and investors do with this indicator is the simple moving average (SMA). However, this will offer an early indication of whether a security's price is accelerating or decelerating and what direction it is heading in. You can also compare it with other trading tools, such as the moving average convergence divergence (MA/DI) indicators. SAR can be used in several strategies and applied to all financial markets. Its most basic functions are the following:
1. Finding a buy point when the price moves above the dotted line and the dots below.
2. Finding a sell or short point when the price moves below the dotted line and the dots move above.
3. Parabolic keeps you in a trade as a trailing stop loss until a signal in the opposite direction occurs.
4. To indicate whether the price is recently rising or falling and when a reversal may occur.
What Does the Parabolic Indicator Tell You?
The most significant criticism of this indicator is its difficulty understanding how it works. However, the indicator is quite simple, and you don't need to be an expert to analyze the data. That's because all you need to do is look at a chart alongside a line. Once you do, you'll notice that this line only tracks one variable: price. The line will move up and down as the price changes, which usually happens whenever a change in market conditions occurs. However, this is why you'll see a parabolic curve form, and it will look like a rising and then falling curve. The main difference between the Parabolic and simple moving average is that the latter doesn't adjust itself to price changes and can sometimes cause it to stray away from the middle, where there should be no bias. Therefore, traders often use a combination of both indicators to create an accurate picture of how the market is moving.
The SAR vs. a Moving Average (MA)
One of the biggest complaints traders have about the indicator is its lack of name recognition, which can confuse new traders. One of the most common questions asked is if they should use it instead of a moving average. While this is a valid question, it's essential to know that this indicator has its unique purpose and shouldn't be confused with other market tools. That's because of the SAR:
The SAR works on the trend, making it especially useful in extreme or volatile markets.
The moving average works on the mean, making it a great tool to use when trading in calmer markets.
Limitations of Using the Parabolic Indicator
The biggest drawback to the SAR is that it's not as accurate as most traders would like. The reason for this is that the indicator works within a price range. In contrast, the moving average only calculates the average within the ranges you set up (usually in 5 or 10-point increments). Another disadvantage to unregulated markets is that it can be challenging to find an outside data source, limiting how accurate a trader's trading plan can be. In addition, new traders often struggle to understand how the indicator works, which makes it harder to use.
The SAR indicator is a great tool that traders have used for many years. While it's considered more of an advanced tool, it can be beneficial if you know how to use it in the proper situation. For example, if you're looking for a way to find support and resistance points in your trading strategy, they can use this indicator ideally with other tools and indicators.
Pros and Cons of the Parabolic SAR
This indicator provides a straightforward way to show the price's value. However, this is accomplished by showing only the price of the security and their latest change in value. You can download it from the link below.
On its own, the Parabolic is not adequate. Using other indicators that complement this one, such as moving averages and trend lines, is recommended to improve performance if used alone.
The Parabolic indicators are not used as much as other momentum indicators, such as the MACD or RSI. However, this is because it's a bit harder to understand. However, suppose you're looking for a good indicator that shows when the price of an asset will zero in on a specific point. In that case, this should be a tool you'll want to consider using in conjunction with other momentum indicators.