The parabolic stop and reverse or parabolic SAR is a procedure which is introduced by J. Welles Wilder, Jr. There are some traded goods like currency exchange (Forex) and securities. By this method, you can find out the potential reversals in the direction of the market price of that traded goods. It is basically a lagging or trend following indicator and trailing stop loss can be set by this indicator. Moreover, to remain within a parabolic curve on the time of strong trading, you can easily find out the entry or exit points of price trading. From the time decay theory, it is known that time is the enemy. Only in the stock trading markets, this indicator works. During sideways phases or ranging SAR, indicator creates whipsaws. By using the parabolic SAR indicator, at first you can find the direction or change in the trend’s direction and after that, to establish the strength of trend you have to use a different indicator, like an average directional index. The parabola is bullish when it is below the market price and it is bearish when the parabola is above the price. A parabola below the market price it can determine as support and also when it is above it may be used as resistance. This parabola can be represented as price areas for gaining profit targets or to stop losses.
About SAR Indicator
For each rending price, the parabolic SAR can be independently calculated. The SAR appears below the price when the price remains in the uptrend and then it tends to meet upwards towards it. At the time of the downtrend, the SAR appears above the price and then tends to meet downwards it. The SAR can be measured one period advance at every step in between a trend. That means by using today’s available data you can easily calculate the SAR value of tomorrow.
The formula for determining SAR value is
SARn+1 = SAR n + α (EP-SARn)
Where SARn = Current Period’s SAR value
SARn+1 = Next period’s SAR value
Extreme point i.e. is determined either the highest value when it reached to the price at the time o up trending or the lowest value at the time of downtrend. The EP value has to be updated with a new value whenever a new current maximum or minimum value is noticed.
The acceleration factor is represented by α value. At first, its value has to be set on 0.02 and a trader can select this value. Whenever a new EP is recorded, each time the acceleration factor is increased by 0.02. That means, whenever you observe a new EP, α will increase. Where the SAR meets the price, the rate will quicken to a point. This is why a maximum value of α is set to 0.02 so that it cannot grow too large. Depending on the trading software or instrument and the trading style, the stock traders can put this numbers. But in trading, it is preferable to set the α to 0.01 so that it will not get affected by local decreasing. The 0.02 value of acceleration factor is preferable at the time of currency or commodity trading.
Parabolic SAR in Trading
Basically, Parabolic SAR is an indicator and especially traders use this indicator to find out what will be the short-term momentum in future of a given asset. This indicator is used to apply to a trading strategy and you can easily get to know that the stop orders where should be placed. The whole calculation of parabolic SAR indicator is bit difficult and how you can practically use this in trading is relatively complex.
The most interesting part is that at any point of time, a trader is totally invested in a position. This is why; the traders who enlarge the trading systems and desire to gain more money in the stock market have a special interest in this indicator.
On the chart of an asset, depending on its momentum the SAR is represented graphically with some series of dots that is set above the price or below the price. When the trend of an asset goes upward, a small dot can be set below to the price and when trend goes downward the dot can be put above the price.
SAR Indicator and Short Sale
The SAR indicator is very much value as it is the easiest procedure for stop-loss order. You can find that, among other technical indicators, SAR indicator has a good reputation for its powerful method of helping traders for gaining profit in stock market. To cover short positions, the professional traders use this indicator. The SAR indicator is highly mechanical and a long or short position can be maintained by the traders. The SAR indicator has the ability to respond to the market changing positions, abolish all the emotions and teach every trader to be in discipline. But there is a disadvantage of this indicator. The signals may go toward many false entries at the time of consolidation. Even for many successful traders, the trading may become tremendously frustrating sometimes being whipsawed in and out.
The most important part is that the perfect position of the SAR representing dots is specially used by the stock traders to determine the transaction signals that are depending on the place of the dot which is related to the asset’s price.
When the most current high market price of a matter has been broken that time the first entry point on buyer side happens and the SAR is set at the most current low price. When the stock price rises, the dots will also rise. This rising will happen slowly at first then with some speed and after that accelerating with the trend. By this accelerating system, the investors can watch the developing trend and its establishment. As the trend develops this indicator will start to move a bit faster and soon the dots can meet the price action. The indicator can works in a good manner at the stock trending moment but in case of price moving sideways, the indicator can meet with many false signals.