The Parabolic SAR is an indicator that can help to identify exit and entry points. Developed by J. Welles Wilder, the Parabolic SAR is also known as the Stop and Reversal system and appears on the chart as a dot either above or below the price action.
The key signal that the Parabolic SAR is used for is called the stop and reversal, which is when the dots change their relationship with the price. For example, the Parabolic SAR switches from above to below the price action, which would be considered bullish as it would signal a change in the trend.
If the SAR starts to appear above the price action, then a downward trend is suggested to have started. An upward trend is in play if the SAR starts to appear below the price action. The Parabolic SAR is most effective in trending markets, while in ranging markets the indicator provides little to no value.
With the Parabolic SAR, we want to see the dots forming a parabolic shape. Often, the Parabolic SAR will switch between being above and below the price action in ranging markets. In a trending market, the indicator will display a series of dots that have a particular curvature that is associated with long-lasting trends.
Parabolic SAR Example
The chart of BTC-USD below shows an example of how to use the Parabolic SAR.
When riding trend, the SAR keeps you in the trade until the indicator suggests a reversal is underway. On higher timeframes, the SAR is usually far enough away from the price to keep the position open for the majority of the trend and prevent the trader from exiting the trade because of a retracement.
The Parabolic SAR can also be used to place stop orders. For instance, if you were long on BTC-USD as the SAR switched below the price action (shown above), stop orders could be placed at the value of the SAR. If the price moves below the SAR, it will indicate a reversal and the dots will then appear above the price action.
Optimising the Parabolic SAR
The sensitivity of the Parabolic SAR can be changed to make it more or less responsive, depending on the instrument you are trading:
- To change the sensitivity, click on the options button of the indicator (the screw symbol).
- Once you click on the screw symbol, you can then change the start, increment and maximum.
Decreasing the ‘start’ will make reversals less likely and move the SAR further away from the price. Increasing the ‘start’ will make reversals more likely and move the SAR closer to the price.
The sensitivity of the Parabolic SAR can also be changed by modifying the ‘Maximum’ but it does not carry as much weight as the ‘start’ variable.