Parabolic SAR

The Parabolic SAR is a very popular indicator used by traders that was developed by J. Welles Wilder. The SAR stands for ‘Stop and Reverse’ which simply implies to stop trading in the present direction and change direction (or reverse).

You can deduce from this simple explanation that the Parabolic SAR will always indicate a direction to be in the trade, i.e. long or short. One of the assumptions made when using the Parabolic SAR is that you are in fact not in a trading range.

Consequently, it is not as effective in trading ranges as it is often changing direction during those periods when there is little else to suggest a breakout from the trading range. This is a similar weakness to moving averages in trading ranges.

You will note on the chart below that the Parabolic SAR is constructed by placing a single dot either above or below the price plot for every period.

Conversely, when the indicator is above the price plot, this indicates that you should be short, i.e. bearish.

Its calculation is quite complex and involves several different variables. These include the extreme point which is the highest (or lowest) point reached during the present long (or short) trade, the significant point, and an acceleration factor. It is the acceleration factor that gives the indicator the parabola appearance and hence the name ‘Parabolic SAR’.

The two parameters required for the Parabolic SAR are the ‘step’ and the ‘maximum’ which are both used in the calculation of the acceleration factor. The typical values used are 2% for the step (or 0.02) and 20% for the maximum (or 0.2).

The calculation of the indicator is designed to place stops along the price plot to assist the trader with the very important exiting decision.