Parabolic SAR means Parabolic Stop and Reverse which was developed by J. Welles Wilder, Jr. This tool is also known as a trend-following indicator. It is used to define signals of potential reversals of price direction. It is also used to set the trailing stop in order to determine the entry or exit points based on prices are staying in or out of the parabolic curve. Parabolic SAR should only be used in trending markets to stay within the trend or exit before the trend changes.
This indicator also offers great flexibility while trading in the market. It can be applied to trade any kind of asset: Forex currency pairs, stocks, options, and futures. Besides, this indicator is also a good match to all sorts of timeframe charts available within the MT4 forex trading platforms.
Since Parabolic SAR is a built-in indicator of Metatrader4, it is quite easy to set it up on the MT4 charts. Just follow a simple 4-step process in order to get done with the Parabolic SAR set up:
- Open the MT4 terminal
- Click on the ‘Insert’ menu then select ‘Trend’ and find the ‘Parabolic SAR’:
- You’ll find a setup dialog box with default values. Click on the ‘OK’ button:
- Once you’re done with the setup, you’ll find your chart like the following image:
Parabolic SAR draws itself by parabolic curves made by a series of ‘dots’ up or below the price candle. When a trend is high, parabolic SAR appears below the price action and starts to move up with an upward acceleration of dotted curves. When the market is trending down, the curve plots itself above the price, starts to move downwards, and accelerates more with the fall of prices. Every dot of Parabolic SAR represents the dynamic stop level of the current trend as well. Therefore, it helps you to determine and update the stop loss position of your trade entry according to the changes in price actions.
Besides determining the stop positions, this indicator can also be used to define market trends, trade signals, and filtering trade signals generated by other trend-following indicators which we’ll discuss throughout this article:
For buy signals, you’ll need to wait until the Parabolic SAR dots start to appear below the price action. Once the dots are plotted below the bars, you may activate the buy entry with the confirmation of the bullish trend of the market. Place the stop loss position below the Parabolic dots and update the stop position according to the change in positions of the dots. Price hits the stop-level or the Parabolic dots below the price action is considered as the trade-exit signals.
When the Parabolic SAR appears above the price action, this represents the beginning of the bearish trend of the market thus, signals for the sell entry. This is an hourly timeframe chart of British Pound vs US Dollar. Once the Parabolic dots are plotted above the price candles, you may trigger the sell entry with a stop loss above the dots. Keep updating the stop loss position according to the change of Parabolic SAR positions and exit the sell entry or take profit once price hits the upper Parabolic dots.
Sometime, Parabolic SAR may deliver frequent signals because of the bearish momentum of price. Frequent signals from a single indicator increase the chance of false indications. For this reason, many traders use a second indicator for better confirmation of the trade signals.
Here is an example:
In general, if you’re using two indicators at a time in the same chart, both indicators should be generating the same trade signal at the same time. If you encounter two different signals at the same moment, that means it is a no-trade situation and it’ll be wise to wait for better confirmations.
This is another hourly GBP/USD chart. We’ve added a 50-day Simple Moving Average (SMA) along with Parabolic SAR in this chart. As you can see, in the middle of the chart, Parabolic SAR had given a sell signal. However, the price had failed to go below the SMA level thus, it is a no-sell signal from the 50 SMA. If you take a close look at the scenario, you’ll notice it’d be a failed trade if you sold according to the Parabolic SAR sell signal. This is how a second trend-following indicator can save you from the false signals generated by the Parabolic SAR.
Now, let’s see how Parabolic SAR with 50 SMA can help you to define trade signals with a better probability of success:
This is an hourly chart of Australian Dollar vs US Dollar and we’ve added the same indicator (50 SMA) along with Parabolic SAR as like as our previous example. At the initial stage, the price was moving below the 50 SMA and according to Moving Average rules, it means a bearish trend signal.
At a point, the price moved above the 50 SMA level, confirming the bullish trend and at the same time, Parabolic SAR started to appear below the price action confirming the validity of the bullish trend. As you can see, after the confirmation of the bullish trend from both indicators, the price surged straight upwards and moved about 100 pips further representing a successful buy set up.
Parabolic SAR is a versatile indicator. It helps traders to define the current market trend, trend reversal, stop-loss positions, and possible trade exit levels. Besides, it can be added to any other trend-following trading indicators or strategies for increasing the better probability of success and enhancing the trading performances.
Furthermore, Parabolic SAR is easier to understand and offers greater simplicity of use compared to other trend-defining tools in the market. This is why this indicator is widely admired by newbie traders besides experienced professionals around the world of financial markets.
If you have any question regarding the parabolic SAR indicator, leave me a comment.