How to Use Parabolic SAR (Stop And Reverse)

  • Before going further to discuss how to use the Parabolic SAR indicator, it's good to know the history of this indicator

    Who doesn't know this one indicator? The Parabolic SAR indicator is an indicator made by a professional trader, as well as the makers of other indicators throughout history.

    He is "J. Welles Wilder, Jr." Wilder was born in the village of Norris, NT, a small village in the city of White, United States, in 1935. During a major depression, he and his family moved around the country for 3 years, before finally settling in Greensboro, United States.

    And in 1986, Wilder owned a new home in New Zealand. He works as a mechanical engineer, journalist, market technician, inventor of indicators, and a basic trading system.

    The beginning of creating Parabolic SAR began in 1972. Wilder began to shift his career to the commodity market. At that time he focused on developing mathematical formulas that could be used to leverage trading systems.

    Since then, he began making a book work in the title "New Concepts in Technical Trading System" outlining the formula.

    From the formula, it is known that the indicator which is then called Parabolic is able to know the trend and saturation of the market. That's where the development of the Parabolic SAR begins. Wilder's book was officially published in 1987.


    Principle Working Indicator

    From the concepts found in Wilder's book, reviewed the working principle of the Indicator Parabolic SAR, including the following:

    • When the parabolic SAR point has changed above, the price is potentially SELL

    • When the parabolic SAR point has changed below, the potential price is BUY

    sar1.jpg

    Parabolic SAR is created with mathematical formulas. Here's the formula:

    SAR n + 1 = SARn + a (EP - SARn)

    Explanation:

    SARn + 1 = tomorrow's SAR value
    SARn = today's SAR value
    EP = Extreme Point; is a record saved during each trend that shows the value of the highest or lowest price
    a = step acceleration factor; this factor will increase by 0.02 each time when the EP value is updated.


    The function of the Parabolic SAR Indicator

    Categorized as a trend indicator, Parabolic SAR (Stop and Reverse) has a variety of alternative functions that are more reliable than just showing the direction of the trend.

    If tracing the meaning of the name, then the main concept of Parabolic SAR is to signify the end of a trend (stop), which then turns (reverse) to form a new trend.

    In fact, the appearance of the Parabolic SAR as points that appear above prices during a downtrend or below prices when an uptrend can indeed be used to recognize reversals. Traders can follow the displacement of the Parabolic SAR point position as a trend reversal moment

    But, do you know if the forex trading indicator which is also often referred to as PSAR still holds one more benefit?

    Yes, besides showing the direction of trends and reversals, Parabolic SAR can also be used as an accurate entry and exit signal.

    This hidden function is not as common as other Parabolic SAR benefits, so it is often referred to as the secret method of using Parabolic SAR. Even though in fact, it's quite easy to apply the forex trading indicator as a sign of entry and exit.


    Characteristics of Parabolic SAR

    Parabolic SAR includes the "Lagging indicator", because waiting for prices to move first, indicators only respond to price movements. This indicator is in the form of points or dots, similar to the Moving Averages (MA) indicator. But this indicator has the characteristic of moving points.


    How to use Parabolic SAR Effectively?

    At the beginning of its creation, the Parabolic SAR indicator was created as a tool to find out when a trend will reversal or turn around. But in its current development, the Parabolic SAR indicator has been used in various ways, namely:

    1. Trend Spotting

    As a trend indicator, Parabolic SAR is very good for detecting market bias, SAR points will appear at the bottom or top of the candle.

    When the market tends to be upward biased (Uptrend), the SAR point will appear at the bottom of the candle. The appearance of this point starts when the price has succeeded in making a new high point in a period.

    Look at the picture below. The price success to penetrate its highest point in the candle with the purple circle. At the time of this breakout, a new SAR point is formed below the candle which indicates a bias in the trend has changed.

    sar2.png

    This also applies to markets with a downtrend; SAR points will appear at the top of the candle. The appearance of this point starts when the price has success to make a new low in one period. The price broke the lowest point on the candle with a purple circle. At this break, a new SAR point is formed above the candle. Look at the picture below.

    sar3.png

    In market conditions that are ranging, these points will also fluctuate and move from one side to the other. This will sometimes make difficult for SAR points to be analyzed. In general, indicators based on Trend Following indeed become helpless when the market is in range conditions.


    2. As Determinants of Entry

    Aside from being a Trend Spotting, the Parabolic SAR indicator can also be used as a reference to determine Entry position. This entry is, of course, a little more complicated than just looking at where the SAR points appear, given the number of false signals that can appear when the market is ranging.

    In a detailed explanation in the book New Concept In Technical Trading Systems, Wilder explained the importance of knowing the major trends in the market before making an Entry. This major trend can be detected by looking at SAR points at a higher time frame, or by using other indicators such as the Moving Average.

    If you already know the major trend, Wilder suggests just opening the position in accordance with the direction of the major trend. For example, if a major trend is detected as uptrend, then it is enough to look for opportunities to rise only. In opening the position, Wilder also emphasized to wait until the appearance of 3 SAR points before entering the market. Look at the picture below for a better explanation.

    sar4.png


    3. As Reference an Exit and Trailing Stop

    Another function of using the Parabolic SAR indicator is the Exit or Trailing Stop manual for positions that are already open.

    Stop Loss when opening a position with the Parabolic SAR indicator is usually placed in the area around the first SAR point that appears after the position is open. The advantage of using this method is that the Stop Loss distance to be used tends not to be too far from the Open position, so the opportunity to secure profits immediately becomes better.

    sar5.jpg

    Apart from being a Stop Loss reference, the Parabolic SAR indicator can also be useful as a reference for Trailing Stop.

    There are times when a price will be biased to one side continuously for a long time. If this happens, of course, you do not want to close the position earlier with less than the maximum profit. Therefore, most trend traders often use Trailing Stop as Exit one position in the market.

    sar6.png

    The Parabolic SAR indicator is very suitable for this. With a varied step, Parabolic SAR is able to quickly detect when a trend is weakening or when it is strengthening.

    In addition, setting the Trailing Stop distance with the Parabolic SAR indicator is better and directed rather than manually setting it. The levels of SAR points are also often used by EA Developers to install Trailing Stop features for robot trading.


    How to use parabolic SAR with other indicators


    Parabolic SAR is also often used in conjunction with other technical indicators. Some of the indicators mentioned here also work by Wilder. Let's look at various alloys of the following indicators with Parabolic SAR.


    1. Average Directional Index (ADX) and Parabolic SAR

    The Average Directional Index, better known as ADX, is one indicator that was also created by J. Welles Wilder. In general, ADX serves to read the strength of a trend in the market. A trend that is strengthening is illustrated by ADX whose value continues to increase, while markets that are being ranged are described with ADX whose value continues to decline.

    How to use Parabolic SAR and ADX is to take advantage of ADX's to see current market conditions and strengths of the trend. Then, you can combine it with Entry according to the Parabolic SAR point.

    sar7.png

    This is one example of a trading system that uses ADX and Parabolic SAR:
    Indicator: Parabolic SAR Default Settings (AF: 0.02, Max: 0.2) and Average Directional Index (Period: 50 with Line + DI and -DI)

    • Buy if the + DI line is above the -DI line and the SAR point gives a Buy signal. Do not enter just because one of the two indicators gives a Buy signal.

    • Sell if the + DI line is below the line - DI and the SAR point gives a Sell signal. Don't enter just because one of the two indicators gives a sell signal.

    • Exit Rules: Line -DI and + DI intersect against signal direction.


    2. Relative Strength Index (RSI) and Parabolic SAR

    The Relative Strength Index, better known as the RSI, was introduced since 1978 and again is an indicator made by Wilder. The RSI indicator is usually used to detect the level of saturation in the market. Usually, if the RSI value is above 70, then the price has been considered Overbought, while when it is below 30 then the price has been considered Oversold.

    In its use with Parabolic SAR, each function can be taken from the indicator and combine it. The RSI indicator can be used as a starting point when and where prices will make a reversal

    sar8.png

    Example system trading with combined Parabolic SAR and RSI

    Indicator: Parabolic SAR Default Setting (AF = 0.02, max = 0.2) and RSI Default Setting (Period = 14)

    • Buy: Only when the RSI is below the level of 30 and the SAR point has appeared below the price.

    • Sell: Only when the RSI is above the level of 70 and the SAR point has appeared above the price.

    • Exit Rules: Can use Exit based on Parabolic SAR points

    Additional Information: These two indicators rarely give signals simultaneously. Because of its Oscillator nature, the RSI will give a signal first followed by Parabolic SAR.


    Scalping  2 Parabolic Sar and MACD

    This trading system uses 2 parabolic SAR and MACD indicators.
    The time frame used is 5 min. The pair that is recommended for trading is a pair that has small spreads such as EUR / USD, GBP / USD, AUD / USD, NZD / USD, USD / JPY, USD / CAD and, EUR / JPY.

    This Parabolic Sar scalping strategy is suitable in any market session because basically we open using a parabolic point, sideways and trending market conditions don't matter if using this system. Please note, do not open a position for at least 15 minutes when the news high will be released soon.

    Forex indicators needed:

    • parabolic SAR (0.01, 0.1)

    • SMA 8

    • MACD (5,8,9) + Parabolic SAR (0.01, 0.1)

    • Stochastic Oscillator (14,3,3)


    Buy Setup

    • A parabolic SAR point appears below the price, this indicates an uptrend signal state.

    • MACD custom above the value 0.

    • When the price is above SMA 8

    • Stochastic is seen as an Oversold condition that is a line crossed at level 20.

    • Buy when all the signals above are confirmed all.

    • Exit point you can use trailing stop use scalping target 5-10 pips


    Sell Setup

    • A parabolic SAR point appears above this price indicating a downtrend signal.

    • MACD custom is below the value of 0.

    • If the price is below SMA 8

    • Stochastic looks overbought, that is, the line has crossed the level> 80

    • Sell when all the above signals are confirmed.

    • Exit point you can use trailing stop use scalping target 5-10 pips

    Place stop loss at swing previous, or max stop loss 12-15 pips.

    sar9.png


    Conclusion

    As a trend indicator, Parabolic SAR works very well when the market is biased in a certain direction. In a market with strong trends, Parabolic SAR is able to offer a low level of risk and high profits. Parabolic SAR is also able to provide reliable Reversal confirmation.

    But in market conditions that are being ranged or sideways, Parabolic SAR is classified as weak and often gives false signals. This is what makes many beginner traders confused by using Parabolic SAR. The final solution, it's better not to enter the market when the market is sideways. But there are also professional traders out there who have found the 'recipe' using the Parabolic Sar indicator in all market conditions, whether it is by combining it with other indicators or alternative analysis methods.