How Is the Parabolic SAR Used in Trading?

What Is the Parabolic SAR?

The parabolic SAR, or parabolic stop and reverse, is a popular indicator that is mainly used by traders to determine the future short-term momentum of a given asset. The indicator was developed by the famous technician J. Welles Wilder, Jr. and can easily be applied to a trading strategy, enabling a trader to determine where stop orders should be placed. (The calculation of this indicator is rather complex and goes beyond the scope of how it is practically used in trading.)

Key Takeaways

  • Parabolic SAR is a technical indicator to determine short-term momentum, helping determine where stop orders should be placed.
  • Trailing stop-loss orders are placed at the SAR value, where a move beyond that level will signal a reversal.
  • The indicator is graphically shown on the chart of an asset as a series of dots, which are placed either over or below the price—depending on the momentum of the asset.
  • The indicator assumes the trader is fully invested in a position at any given time and tends to perform best in markets with a steady trend.
  • Note that the calculation of the parabolic SAR is rather complex.

Understanding the Parabolic SAR

One of the most interesting aspects of this indicator is that it assumes a trader is fully invested in a position at any point in time. For this reason, it is of specific interest to those who develop trading systems and traders who wish to always have money at work in the market.

The parabolic SAR indicator is graphically shown on the chart of an asset as a series of dots placed either over or below the price (depending on the asset's momentum). A small dot is placed below the price when the trend of the asset is upward, while a dot is placed above the price when the trend is downward.

Many traders will choose to place their trailing stop-loss orders at the SAR value, because a move beyond this will signal a reversal, causing the trader to anticipate a move in the opposite direction. In a sustained trend, the parabolic SAR is usually far enough removed from price to prevent a trader from being stopped out of a position on temporary retracements that occur during a long-term trend, enabling the trader to ride the trend for a long time and capture substantial profits.

Markets and the Parabolic SAR

The parabolic SAR performs best in markets with a steady trend. In ranging markets, the parabolic SAR tends to whipsaw back and forth, generating false trading signals. Wilder recommended augmenting the parabolic SAR with the use of the average directional index (ADX) momentum indicator to obtain a more accurate assessment of the strength of the existing trend.

Traders may also factor in candlestick patterns or moving averages. For example, price falling below a major moving average can be taken as a separate confirmation of a sell signal given by the parabolic SAR.

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