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An Introduction To The Parabolic SAR Indicator
Education | 27 August 2013
By: Stuart McPhee
Articles (22) Profile

Indicators are the result of mathematical calculations done on price data and are displayed on charts. Using indicators, it is possible to anticipate the direction of a price’s movement with a reasonable level of accuracy. It should be noted that no indicator is perfect and no single indicator will be right all the time.

The Parabolic SAR (Stop and Reverse) indicator is an effective trend following indicator that was developed by J. Welles Wilder. The concept was first introduced in his book, “New Concepts in Technical Trading Systems”, published in June 1978 – an eternity ago in the field of technical analysis.

There are two variables in the Parabolic SAR indicator – an acceleration factor and maximum step. In many platforms (OANDA’s fxTrade included), the default settings are 2 per cent for the acceleration factor (commonly shown as 0.02) and 20 per cent for the maximum step (commonly shown as 0.2).

As you will see in the chart below, the Parabolic SAR is plotted on a daily chart of the EUR/USD, and it consists of dots placed either above or below each period’s candlestick or bar.

You will notice for the most part, the black dots appear below each candlestick when the price is moving higher, and conversely, appear above each candlestick when the price is moving lower. Therefore, a possible interpretation of the Parabolic SAR is to be long when the black dots appear below price and short when they are above.

Toward the end of the chart you will notice how the black dots change from above to below and back again a little more frequently. This is as a result of the price starting to flatten out as it lacks direction. Thus when a trend is not as obvious, the indicator may be less effective as it can provide more false signals.

Finding A Suitable Exit
Another possible use of the Parabolic SAR is to indicate suitable exit points. You could close long positions when the price falls below the SAR and close short positions when the price rises above it. The Parabolic SAR is quite popular in this role as it presents a relatively easy way of setting trailing stops.

As always, it is worth conducting your own research and testing to validate the Parabolic SAR as a useful and effective part of your own trading strategy.

The formula for the Parabolic SAR is reasonably complicated and is definitely beyond the scope of this article. It is worth experimenting with the two parameters for the indicator and testing different variables. I would suggest you refer to Wilder’s book for an explanation of the calculations.

Get a free OANDA demo account to experiment with the Parabolic SAR indicator on our award-winning fxTrade platform.

Stuart has more than 16 years of trading experience under his belt and specialises in technical market analysis of major currency pairs. Apart from being the author of several bestselling trading books, with his most recently released book "Trading in a Nutshell", Stuart contributes to daily newletters and blogs. He also produces articles and videos on the how tos of technical tradings. For more information of Stuart, you can follow him on twitter @stuartmcphee or check him out on Google+.

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