While I generally like to trade with few indicators and very little on my charts, the Parabolic SAR is one indicator that can be quite valuable. Short for Parabolic Stop-and-Reverse, this indicator provides both entries and exits.

The indicator is composed of a series of dots, either above or below the price. When dots move from below to above the price bars, it is time to get out of longs or get short. When the dots move below the price bars it is time to get long, or get out of short positions. While the indicator provides buy and sell signals, they should not be trusted blindly. Therefore, the Parabolic SAR just provides potential trades. You'll then want to look at the stock from other technical angles to see if the buy signal is worth taking.

In the four cases below, I am mainly looking to see if a dominant trend is in place. Then I'll look to other indicators, such as volume or chart/price patterns, to see if they confirm the signal as well.

Health Care REIT (NYSE:HCN) been in a strong uptrend, and a Parabolic SAR buy signal indicates another wave higher may be starting. On May 13 the indicator moved below the price, after having been above for several days prior. The dominant trend is up, which could be confirmed with trendlines, but also by simply looking at the the amount of time the stock has spent trading above the Parabolic SAR dots. Despite the relatively high price, volume is also standing firm. Average volume is higher due to the volume spike on May 9, but even without that volume is comparable to prior uptrend months.

To me this indicates a healthy trend which could likely continue. A stop-loss for long trades can be placed with the Parabolic SAR, currently at $73.60. The SAR will continually rise though, acting as a trailing stop and, therefore, your stop loss order can rise with it. Eventually the price will hit a dot (and the dots will move above the price) signaling a potential reversal to the downside. 



 

While Honda Motor Co. (NYSE:HMC) is in a uptrend, it is much less pronounced than the Health Care REIT is. As of May 13 the price is above the Parabolic SAR indicator dots, signaling a potential buy. Overall I think there may be a bit more upside, but there is resistance on the long-term charts between $41 and $41.25. If the stock can rise though that area the potential is greater for a bigger up swing to emerge. I'd prefer to see the stock move above that threshold before considering a long position. The Parabolic SAR once again provides the stop for a long position, currently at $39.18, but that will continually rise, acting as a trailing stop.



 

Hillshire Brands (NYSE:HSH) has been a classic example over the last several months of trading with a dominant trend using the Parabolic SAR. Since November, the price has predominantly stayed above the SAR dots and corrections have been relatively short-lived. If this pattern continues to hold, then another upside move into the $38 to 38.20 area is quite possible. The indicator provides a stop level of $33.20, currently. This risk is a bit high for what I think the upside is, but that risk will continually shrink so, barring any drastic sell-off, I like the long. If at any point the dots move above the price, take the profit (or loss) and exit.



 

The price of Walgreen Co. (NYSE:WAG) stock price also moved above its SAR on May 13. This stock is also in a well-defined uptrend, adding credibility to the SAR buy signal. Volume is holding steady, which is a positive sign. Since late 2012, when the price moved above the SAR, the following up move has lasted for some time, except for a period in February 2013 when when the stock moved predominantly sideways. Overall I like the long here. The SAR provides a fairly tight stop, currently at $47.75, and risk will continue to diminish as the trade unfolds. As with any SAR long trade, if the dots flip above the price, take profits/losses.



The Bottom Line
The Parabolic SAR can be a great indicator, as it provides trade signals as well as a trailing stop. Ideally, though, you want to trade signals that occur in the same direction as the dominant trend. A choppy market will result in multiple false signals, multiple losses or insubstantial profits. Risk management is always up to the trader though. While the indicator provides the entry and exit, taking the proper position size has just as much (or more) impact than where the stop-loss is placed. Trade within your risk tolerance, and use the Parabolic SAR to point out potential trade candidates that deserve a closer look.

At the time of writing, Cory Mitchell did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Options & Futures

    Trailing-Stop/Stop-Loss Combo Leads To Winning Trades

    Combine trailing stops with stop-loss orders to reduce risk and protect portfolio value.
  2. Options & Futures

    Manage Risk With Trailing Stops And Protective Put Options

    Using the right strategy can lower the risk of failure and protect your profits.
  3. Active Trading Fundamentals

    The Stop-Loss Order - Make Sure You Use It

    It's a simple but powerful tool to help you implement your stock-investment strategy. Find out how.
  4. Technical Indicators

    Introduction To The Parabolic SAR

    Take a closer look at this indicator, which during a trending period, is a very useful and accurate tool.
  5. Trading Strategies

    How To Buy Penny Stocks (While Avoiding Scammers)

    Penny stocks are risky business. If want to trade in them, here's how to preserve your trading capital and even score the occasional winner.
  6. Chart Advisor

    Stocks to Short...When the Dust Settles

    Four short trades to consider, but not quite yet. Let the dust settle and wait for a pullback to resistance for a higher probability trade.
  7. Technical Indicators

    Using Moving Averages To Trade The Volatility Index (VIX)

    VIX moving averages smooth out the natural choppiness of the indicator, letting traders and market timers access reliable sentiment and volatility data.
  8. Chart Advisor

    Traders Step Back to Assess Commodities Damage

    Traders are turning to these exchange-traded notes and exchange-traded funds to analyze key commodities and determine what could be coming next.
  9. Chart Advisor

    Strategizing for a Market Fall...or Rally

    The downtrend isn't confirmed yet, so be prepared with trades for whether the stock market rallies or continues to fall. Here's how to do it.
  10. Trading Strategies

    Are You a Trend Trader or a Swing Trader?

    Swing traders and trend traders execute market timing strategies that require different skill sets.
RELATED TERMS
  1. Fintech

    Fintech is a portmanteau of financial technology that describes ...
  2. Indicator

    Indicators are statistics used to measure current conditions ...
  3. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
  4. Mass Index

    A form of technical analysis that looks at the range between ...
  5. Money Flow Index - MFI

    A momentum indicator that uses a stock’s price and volume to ...
  6. On-Balance Volume (OBV)

    A momentum indicator that uses volume flow to predict changes ...
RELATED FAQS
  1. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  2. How are double exponential moving averages applied in technical analysis?

    Double exponential moving averages (DEMAS) are commonly used in technical analysis like any other moving average indicator ... Read Full Answer >>
  3. How do you know where on the oscillator you should make a purchase or sale?

    Common oscillator readings to consider making a buy or sale are below 20 or above 80, respectively. More aggressive investors ... Read Full Answer >>
  4. What are the alert zones in a Fibonacci retracement?

    The most commonly used Fibonacci retracement alert levels are at 38.2% and 61.8%. A 50% retracement level is also commonly ... Read Full Answer >>
  5. How was the Fibonacci retracement developed for use in finance?

    The use of Fibonacci retracements in stock trading was popularized by noted technical analysts W.D. Gann and R.N. Elliott. ... Read Full Answer >>
  6. How reliable is the Fibonacci retracement in predicting stock behavior?

    The use of the Fibonacci retracement is subjective. There is no objective method to verify one application of the Fibonacci ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!