PSAR or The Parabolic Stop and Reverse was created by J. Wendell Wilder. It is plotted as dots or a single parabolic line when there is an uptrend and it is shown over or above the price bars during a downtrend.
There are three main uses for parabolic SAR. It first emphasizes the trend or direction of the price at the moment. Additionally, it offers potential entry points. Third, it offers potential signals on when to exit.
Calculation of Parabolic SAR
The Extreme Price or EP and an Acceleration Factor or AF are used by the PSAR in order to determine where the dots will be placed.
- Prior PSAR + Prior AF (Prior EP – Prior PSAR)
- Prior PSAR – Prior AF (Prior PSAR – Prior EP)
- EP = is the downtrend’s lowest low and the uptrend’s highest high which is updated every time a new high or low is reached.
- AF = the default is 0.02 and is increased by 0.2 every time a new EP is reached but with a max of 0.20.
This computation places a dot below the price action that is rising or on top of the price action that is falling. These dots aid in illuminating the present price direction. Because the dots flip over the top of the price bars, the indicator is known as a stop and reverse.
How to Use the Parabolic SAR in Trading
When there is an uptrend or when dots travel under the price bars, it is suggested that you make a buy order. In contrast, one should make a sell order if the dots move above or over the price bars which suggests a downtrend.
These consistent trade signals might result in a string of losing trades when prices are only making minor movements in each direction. However, when there are large price movements back and forth, this can be advantageous.
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In order to identify whether the trend is up or down, it is best to evaluate the action of prices for the day. The overall direction of a parabolic SAR trend can also be determined using other indicators like the trendline or moving averages.
Only act on trade signals that are in line with the general trend if there is one. Keep in mind that it is a good practice to only follow signals that suggest a short trade or when the dots flop over the price bars and remember to exit when the indicator dots flip under the price bars if the trend is downwards. In this approach, the indicator is made use of for what it is best at spotting trends.