How to Use the Parabolic SAR Indicator

September 01, 2021 10:00 UTC
Reading time: 9 minutes

Some of the most powerful moves in the financial markets occur when a trend builds. Once a trend takes hold, it may often exceed general expectations for how long it will persist, leaving only the most skilled traders to profit to the maximum.

Being able to properly analyse trending states of the market is therefore an extremely useful ability, which is exactly why there are so many different tools that attempt to do the job. This article is going to take a look into one of the major indicators in the area: the Parabolic SAR indicator.

The Parabolic SAR Indicator Explained

The Parabolic SAR, or Parabolic Stop and Reverse, not only helps identify trends - but also, as the full name suggests - tells you when to close out your trade and reverse the direction. Sounds pretty useful, doesn't it? 

The Parabolic SAR is one of a range of trading techniques developed by J. Welles Wilder - a commodities trader and a hugely influential technical analyst.

His book 'New Concepts in Technical Trading Systems' introduced some of the cornerstones of modern technical analysis methods, including the Average True Range (ATR), the Relative Strength Index (RSI), as well as what he called the 'parabolic time/price system'. This last item is the indicator which we are focusing on, the Parabolic SAR indicator.

The indicator plots a curved pattern on a price chart, which describes potential stop and reverse levels. The shape of this pattern reminded Wilder of the parabolic curve found in classical geometry and mechanics, which is where the indicator's name comes from. 

The Parabolic SAR Calculation

As we stated above, the indicator plots stop and reverse levels on the chart. These are calculated from the Parabolic SAR formula, which is as follows:

  • SARNEW = SARCURRENT + AF x (EPCURRENT - SARCURRENT)

Where the formula terms are defined as below:

  • AF = Acceleration Factor - a changing value that increases in set increments for each period that a new high (for long positions, or new low for shorts) is reached for the trade. Wilder proposed a value of 0.02 for the initial value of AF, which would then increase in steps of 0.02 until it reaches a maximum value of 0.20.
  • EP = Extreme Point - the highest or lowest price seen for the duration of the current trend (highest for an uptrend, lowest for a downtrend).

The curve of the Parabolic SAR indicator is intended to provide a guide to the path of a trending market. Wilder contended that a trending market will have a high probability of remaining within the constraints of the curve on the chart. It follows that if the price fails to do this and instead breaks through the curve, the trend may have run out of steam. It is at such points in time that you should stop and reverse your position.

Understanding the calculations behind the Parabolic SAR indicator can aid your understanding of how it works, what the various parameters mean and how to modify its usage.

However, remember that although it is useful to know, you do not need to worry about conducting the calculations yourself! This is because, with both MetaTrader 4 (MT4) and MetaTrader 5 (MT5), the trading platform will take care of the Parabolic SAR calculations for you!

How to Use the Parabolic SAR Indicator in MetaTrader

Both MT4 and MT5 come with a wide range of technical indicators by default - one of which is the Parabolic SAR, meaning that as soon as you have downloaded your trading platform, you can start trading using the indicator!

You can find the indicator in both MT4 and MT5 by heading to the 'Navigator' window on the left-hand side of the screen. Here, you will see a folder entitled 'Indicators', with a subfolder called 'Trend' - this is where the Parabolic SAR is located.

Once you have double clicked on the icon, you will be presented with a dialogue box which allows you to adjust the Parabolic SAR settings, as shown below.

Depicted: Admirals (formerly Admiral Markets) MetaTrader 5 - Parabolic SAR Settings

The Parabolic SAR Settings

There are really only two key settings, as you can see from the image above. These are listed as 'Step' and 'Maximum'.

Step is the size of the acceleration factor. The default value for the step in MT4 and MT5 is set at 0.02. The acceleration factor starts with this value and then increases by the step size with each new high (or low for short positions), up to the value defined by the Maximum parameter. The default maximum value in both MT4 and MT5 is 0.20.

What are the best Parabolic SAR settings?

Unfortunately, there is no correct answer to this question. It will ultimately depend on individual factors such as your style of trading, the time frame you are trading on and your trading strategy. You will be able to discover what Parabolic SAR settings work best for you through experimentation, though the default values are the best place to start.

Generally speaking, the smaller the acceleration factor, the less closely it will trail the price. Conversely, the higher the acceleration factor, the closer it will move to the price. Consequently, a reversal is more likely the higher the acceleration factor. It's important not to have too high an AF or you will reverse too often, and subsequently fail to properly ride each trend.

Of course, whether you want a higher or lower sensitivity to the price, and therefore more or less reversals, is tied to your trading aims. For example, the best Parabolic SAR settings for scalping will likely need more reversals than a long-term trading style – thus, a scalper may find a higher AF more appropriate.

Wilder found that the default value of 0.02 worked best for him, but stated that anything between 0.018 to 0.021 would work well. He recommended not setting the maximum as anything higher than 0.22 – still, the best way for you to find on your own ideal Parabolic SAR settings is through trial and error.

Testing different values and seeing for yourself which yields the best results in tandem with your own strategy will also give you more confidence in your methods. The best way to do this is with a risk-free demo trading account, which allows you to trade using virtual currency in real-market conditions.

How to Trade Using the Parabolic SAR Indicator

The image below shows an hourly chart of GBP/USD with a Parabolic SAR added using the default settings in MetaTrader 5.

Depicted: Admirals MetaTrader 5 - GBPUSD H1 Chart. Date Range: 24 August 2021 - 1 September 2021. Date Captured: 1 September 2021. Past performance is not a reliable indicator of future results.

The Parabolic SAR's green dots mark where you should place your stop level. Notice how the stop always trails the market movement; it only ever moves closer to the market, and never moves further away. As the trend continues, the increasing acceleration factor means that the stop moves closer to the price.

If the market does not continue to move favourably, the indicator tells you to stop and reverse. This is really quite simple, and it follows that Wilder's rules for trading with the Parabolic SAR are not particularly complicated.

The guidelines for Wilder's Parabolic SAR strategy are as follows:

  • The SAR dots beneath the current market price point to an uptrend;
  • The SAR dots above the market price point to a downtrend;
  • Enter a position when the price penetrates the SAR – buy if the price crosses above the SAR and sell if the price crosses below the SAR;
  • You stop and reverse your position when the price crosses the SAR again.

You can aim to improve your Parabolic SAR strategy by using other indicators to aid your decision-making. For example, it can be useful to use a different trend indicator, such as the ADX, to establish that you are actually in a trending market, as opposed to a sideways moving market. It's important to note that the Parabolic SAR is not designed to work in a sideways market.

Knowing the overall direction of the long-term trend can also be useful for placing your opening trade – you may find it advantageous to only place an opening trade in the direction of the overall trend, as defined by another trend indicator. Taking this line of thinking a step further, an alternate method of trading is to only take trades in the direction of the overall trend and to close them when the price crosses the SAR, instead of actually reversing your position.

When choosing which supplementary indicator to use in order to support your Parabolic SAR trading strategy, you might find it useful to pick from a wider selection, rather than the standard list of MT4 and MT5 indicators. The MetaTrader Supreme Edition is a plugin for both MetaTrader 4 and MetaTrader 5 that enables you to substantially expand the array of tools at your disposal. It even comes with a powerful 'Trading Simulator' that enables you to easily backtest your strategies and objectively measure their effectiveness.

Final Thoughts

J. Welles Wilder stated that the Parabolic SAR "squeezes more profit out of an intermediate move (which lasts for two or three weeks) than any method I know". Decades have passed, but the tool remains widely used, which is a testament to its effectiveness. Furthermore, the indicator can be tailored to a wider cross-section of time frames than the quote above suggests.

There is no reason to think that you cannot apply a Parabolic SAR strategy to shorter time frames, such as tick charts, as well as to much longer ones, such as daily or weekly charts. The general principle remains the same across them all, provided that you are trading in a genuinely trending market.

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

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