What is the 'Parabolic Indicator'

The parabolic indicator, developed by J. Wells Wilder, is used by traders to determine a trend’s future direction. The indicator uses a trailing stop and reverse method called "SAR," or stop-and-reversal, to identify suitable exit and entry points. Traders also refer to the indicator as the parabolic stop and reverse (PSAR).

The parabolic indicator appears on a chart as a series of dots, placed either above or below a security's price, depending on the security's direction. A dot is placed below the price when it is trending upward, and above the price when it is trending downward.

Example of the Parabolic Indicator

Image depicting the parabolic indicator.

BREAKING DOWN 'Parabolic Indicator'

The parabolic indicator generates buy or sell signals when the position of the dots moves from one side of the security's price to the other. For example, a buy signal occurs when the dots move from above the price to below the price, while a sell signal occurs when the dots move from below the price to above the price. Traders also use the PSAR dots to set trailing stop-loss orders.

Calculating the Parabolic Indicator

EP = The highest high in the current uptrend, or the lowest low in the current downtrend.

AF = Starts with a default of 0.02 and increases by 0.02 each time a new EP occurs; maximum of 0.20.

Rising Parabolic SAR = Previous SAR + Previous AF (Previous EP – Previous SAR) = Current SAR

Falling Parabolic SAR = Previous SAR – Previous AF (Previous SAR – Previous EP) = Current SAR

Charting software automatically calculates the PSAR, which means traders only need to know how to interpret the indicator’s signals.

Trading with the Parabolic Indicator

The parabolic indicator generates a new signal each time it moves to the opposite side of a security’s price. This ensures a position in the market always, which makes the indicator appealing to active traders. The indicator works most effectively in trending markets where large price moves allow traders to capture significant gains. When a security’s price is range-bound, the signals generated by the indicator may not produce enough profits to cover commission costs.

For best results, traders should use the parabolic indicator with other technical indicators that indicate whether a market is trending or not, such as the average directional index (ADX), a moving average or trendline. For example, traders might confirm a PSAR buy signal with an ADX reading above 30 and/or a break above a long-term downtrend line. (To learn more, see: How is the Parabolic Indicator Used in Trading?)

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