How Wall Street Pros Use Stop and Reverse Indicator in Market Trending
Trend indicators are among the most important indicators in the financial markets. You have likely heard about indicators like moving averages, the average directional movement index, and standard deviation. These are very popular, especially if you watch financial media regularly.
The Parabolic SAR is another trend indicator that is very popular also. It is also among the most different indicator because of its appearance.
In this article, we will look at the Parabolic SAR and how to use it.
What is a Parabolic SAR?
The Parabolic SAR is a trend following indicator that was developed by Welles Wilder. As we had explained before, trend indicators are lagging indicators because they use historical data to help forecast the future.
The SAR stands for stop and reverse.
As with other trend oscillators, and volume indicators, it is not important for you to know how the indicator is calculated. However, if you want to get to know more about the indicator, the following is the formula.
Stop and Reverse Formula
First, you need to calculate the prior SAR, the extreme point, and the acceleration factor.
The prior SAR is the SAR value for the previous period while the extreme point is the highest point of the current uptrend.
The acceleration factor starts at 0.02 and increases by 0.02.
As a result, the current SAR formula is calculated as follow:
|Current SAR = Prior SAR + Prior AF(Prior EP – Prior SAR)|
The falling SAR is calculated by using the same formula as the previous one.
How to Use a Parabolic SAR Effectively
There are a few things that you need to know when using the Parabolic SAR.
First, the indicator is only used when the market is trending. It would be wrong to use it when the market is ranging. In this period, the results you will see will probably be wrong.
Second, the indicator is only used when using candlesticks. It cannot be used well when using line and bar charts.
When you apply the SAR indicator, you will see dots as you can see on the chart below.
The interpretation is that the pair will continue moving lower when the dots are above the financial asset. As shown above, the red dots appear when the pair is moving lower.
This changes when the asset starts moving higher. When this happens, the dots on the asset change.
Parabolic SAR Strategy for Day Traders
Therefore, the Parabolic SAR is fairly simple to use. All you need to do is to apply it and see what it is indicating.
You can tweak the acceleration factor and the acceleration limit. The default factor and limit are 0.02 and 0.2. Most traders prefer using the default numbers.
As with all indicators, there are several things that you need to know.
First, you can use the Parabolic SAR to know where to place the stop loss. Second, while the Parabolic SAR can be used by itself, it is always recommended that you use it in combination with other indicators and tools like the Fibonacci Retracement.
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