Parabolic SAR

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    The parabolic SAR, or parabolic stop-and-reversal, is an indicator used to determine entry and exit points by showing potential reversals in price movement.

    A sell signal occurs when the dots appear above the candles and a buy signal occurs when the dots appear below the candles.

    Colours that should be used for parabolic SAR

    The parabolic SAR can also be used to set stop loss orders, for example, recent swing highs or swing lows.

    At the beginning of a new trend, the stop loss has to be more generous to absorb the price movement. When the trend is developing, the stop loss has to be adjusted and trailed behind, as new dots appear.

    It is important to note that parabolic SAR is only effective in trending markets. In ranging markets, the indicator will be too slow to catch the price movement effectively because it is still a trend-following (and therefore lagging) indicator.

    Calculation

    The parabolic SAR is calculated one period in advance, using the following formula:

    SAR n+1 = SAR n + a (EP – SAR n)

    “SAR n” is the SAR of the current period and “SAR n+1” is the SAR of the next period.

    EP is the highest value reached during the current uptrend or the lowest value when in a downtrenda is the acceleration factor and can be chosen by the trader; the default is 0.02. Each time a new EP is reached, the initial a is added to the current a — in other words when a = set to 0.02 the first time a new EP is reached a will become a + 0.02 = 0.04, then when a new EP is reached it will become 0.06 and so on. To prevent it from becoming too large, the EP is capped. The cap can be set by the trader as well and has a default of 0.20.

    There are, however, two cases when the calculation of the SAR will differ from the value calculated with the formula above.

    1. If the value of the SAR n+1 is lower than SAR n in an uptrend or higher in a downtrend, SAR n+1 will be set equal to SAR n.
    2. When the price of an asset becomes equal to the SAR, a new trend is detected and the calculation is reset. When this happens the first SAR will become equal to the EP of the trend before the trend that has just ended. EP will be set to the maximum of the new trend and a will also be reset to its initial value.

    Further reading

    Learn more about the parabolic SAR: