How to Use the Parabolic SAR Indicator
Amongst the vast array of technical indicators available to traders is the Parabolic SAR, which is designed to help traders identify trends as well as potential reversals in price. It can also be used to provide entry and exit signals too and, best of all, it is very simple to interpret. Sounds pretty useful, doesn’t it?
In this article, we take an in-depth look at the Parabolic SAR indicator. We will examine the Parabolic SAR formula, demonstrate how to use Parabolic SAR and much more!
Table of Contents
What Is Parabolic SAR Indicator?
The Parabolic SAR, or Parabolic Stop and Reverse, not only helps identify trends - but also, as the full name suggests – helps traders decide when to close their trade and reverse the direction.
It is one of a range of trading indicators, including the Average True Range (ATR), the Relative Strength Index (RSI), which were developed by J. Welles Wilder - a commodities trader and hugely influential technical analyst.
The Parabolic SAR indicator, sometimes referred to as the PSAR indicator, appears on a price chart as a series of dots either above or below the asset’s price. Dots below an asset’s price indicate an uptrend, whilst dots above the price indicate a downwards trend.
How to Calculate Parabolic SAR
These dots which make up the Parabolic SAR indicator are calculated from the Parabolic SAR formula. There are actually two slightly different formulas, depending on whether the PSAR indicator is rising or falling.
Where:
- AF = Acceleration Factor
- A changing value that increases in set increments for each period that a new high (for rising PSAR) or new low (for falling PSAR) is reached. 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 high in the current uptrend or the lowest low in the current downtrend.
Understanding how to calculate Parabolic SAR indicator can aid your understanding of how it works, what the various parameters mean and how to modify its usage.
However, you do not necessarily need to worry about calculating the Parabolic SAR formula yourself! Fortunately, both MetaTrader 4 (MT4) and MetaTrader 5 (MT5) will take care of the PSAR calculation for you!
How to Use Parabolic SAR MT4 and MT5
Both MT4 and MT5 come with a wide range of technical indicators by default - one of which is the Parabolic SAR.
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. Once you are happy with the settings, click OK to apply the indicator to your price chart.
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, up to the value defined by the Maximum parameter. The default maximum value in both MT4 and MT5 is 0.20.
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.
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.
Of course, which settings work best will depend on the trader in question and their individual strategy. Whilst it is usually recommendable to start with the default settings, experimenting with different values can help determine what the best Parabolic SAR settings are for you.
A risk-free demo trading account from Admiral Markets allows you to trade using virtual currency in realistic market conditions, making it the ideal place to experiment with different PSAR indicator settings or test out a Parabolic SAR strategy. Click the banner below to open a demo account today:
How to Trade with a Parabolic SAR Strategy
The image below shows an hourly chart of GBP/USD with a Parabolic SAR added using the default Parabolic SAR settings in MetaTrader 5.
As well as being used to indicate trends, reversals and entry and exit signals, the Parabolic SAR's green dots can be used for setting stop-loss levels. 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 PSAR indicator dots shift to the other side of the price, indicating to stop and reverse. The indicator really is quite simple to read, 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 buy position if the PSAR moves below the price or a sell position if the PSAR crosses above the price;
- Stop and reverse the position when the price crosses the PSAR again.
Drawbacks of the PSAR Indicator
It is important to bear in mind that the PSAR indicator is constantly producing signals and not all these signals will be accurate or lead to successful trades. You will note from the image above that there are a number of false signals during the timeframe.
Consequently, traders may want to act more cautiously when constructing their own PSAR trading strategy. For example, instead of instantly reversing a position when the PSAR crosses above or below the price, traders may want to wait for confirmation of a new trend.
Traders can also try and improve their Parabolic SAR strategy by using other indicators to aid decision-making. For example, it might 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. The Parabolic SAR is not designed to work in a sideways market.
As always, when experimenting with new trading strategies, it is best to do so on a demo trading account before transitioning to the live markets.
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FAQ
What do Parabolic SAR dots indicate?
When the Parabolic SAR dots appear below an asset’s price, it indicates that there is currently an uptrend. On the other hand, if the dots appear above an asset’s price, it indicates a downtrend. When these dots flip to the other side, it indicates that a change in trend direction may be taking place.
What is the best setting for Parabolic SAR?
The best Parabolic SAR settings will ultimately depend on individual factors such as the trader’s style, the time frame they are trading on and their trading strategy. It is usually preferably to start with the default values and discover which Parabolic SAR settings work best by experimenting on a demo trading account.
About Admiral Markets
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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.
