Forex Education: How To Use The Parabolic SAR
This article continues our forex education in technical analysis, looking at charts and indicators. Here we will focus on the indicator known as the Parabolic SAR (Stop And Reversal), developed by Welles Wilder.
Most indicators involve identifying a trend in price movements, which of course is a very important skill to have. The trend is your friend as they say, and traders need to be able to place orders as accurately as possible at the start of a new trend. But at the same time it is important to know when a trend is ending, so that you can close your trade. If you do not do this, you could easily see the market wiping out all of your profits and turning a winning trade into a loser.
This is where the Parabolic SAR comes into play. Its calculations are complicated and fortunately you do not need to understand that side of it because any good charting package will produce the indicator for you automatically. It appears as a series of dots above or below the prices which can indicate a possible reversal in the trend.
The dots will normally be below the candles during an uptrend and above them during a downtrend. When the dots cross the line of the candles or line that charts price movements, you have a signal that the trend is reversing and it is time to exit.
You can also use the dots to place trailing stops. In a fast moving market this may be a better way to ensure you close out a profitable trend as soon as the reversal takes hold, rather than relying on watching the chart every moment.
During most trends the Parabolic SAR will indicate a wider trailing stop at the beginning of a trend, tightening up as the trend gets under way. This means that toward the end of the trend the stop will be triggered by fairly small movements in the price. At this point meaningless whipsaws are less likely and a small change in direction is more likely to be the beginning of a reversal, so using the Parabolic SAR to set trailing stops can help to protect your profits.
The Parabolic SAR is best used during actual trends, rather than short term fluctuations. You will already have determined the existence of the trend using other indicators and you can start to take account of the Parabolic SAR once you can see that the trend is established and moving in the right direction. It is not so useful in a sideways or choppy market.
Although mathematically complex, the Parabolic SAR is straightforward to use. You should be able to increase your profits from successful trades by adding this indicator to the basket of tools that you have mastered through your forex education.