Parabolic SAR

The Parabolic SAR (Stop and Reverse) is a technical analysis tool developed by J. Welles Wilder, primarily used to determine the direction of an asset’s price and to signal potential points of reversals in its trend. The indicator is depicted as a series of dots placed either above or below the price bars on a chart.

Key Features of Parabolic SAR:

1. Trend Identification:
   • When the dots are below the price, it indicates an upward trend, suggesting that you should be holding a long position.
   • When the dots are above the price, it indicates a downward trend, signaling a short position or a time to exit long trades.
2. Reversal Signals:
   • A trend reversal occurs when the dots switches from being below the price to above the price.
3. Calculation Method:
   • Long position: SAR(i) = SAR(i – 1) + AF * (HIGH(i – 1) – SAR(i – 1))
   • Short position: SAR(i) = SAR(i – 1) + AF * (LOW(i – 1) – SAR(i – 1))
     • SAR(i – 1) : value of Parabolic SAR on the previous bar;
     • AF: acceleration factor;
     • HIGH(i – 1): maximum price for the previous period;
     • LOW(i – 1): minimum price for the previous period.
   • The indicator value increases if the price of the current bar is higher than the previous bullish price, and vice versa. At the same time, the acceleration factor will accelerate to converge Parabolic SAR and the price. Hence the faster the price grows or sinks, the faster the indicator approaches the price.
4. Advantages: Easy to use
5. Limitations:
   • Less effective in ranging markets
   • The standard settings might not work equally well across all assets or time frames, requiring adjustments to the AF value.
   • A study of Parabolic SAR based on back-testing over a 12-year period to 2023 on the Dow Jones Industrial Average 30 stocks, demonstrated using Parabolic SAR with a standard OHLC chart resulted in a 19% win rate. Using PSAR with a Heikin Ashi chart produced a 63% success rate (reference: https://en.wikipedia.org/wiki/Parabolic_SAR).  The effectiveness is sensitive to which type of chart you choose.
6. Practical Application:

• • Entry and Exit Points: Traders often use the Parabolic SAR to time their entries and exits. For example, they might enter a trade when the dots flip, indicating the start of a new trend.
  • Trailing Stop: The indicator can also be used as a trailing stop. As the trend progresses, traders can adjust their stop-loss levels based on the indicator, locking in profits as the price moves in their favor.
  • The Parabolic SAR is a versatile tool, but it is often combined with other indicators, such as moving averages or trend lines, to improve accuracy and reduce the risk of false signals.