The parabolic SAR and RSI indicators can compliment each other very well when looking for buy and sell signals on currency pairs. The parabolic SAR is able to confirm the trend direction whereas the RSI can pinpoint extreme market conditions to help us time the entry into the trend. That being said, I wouldn’t blindly take all of the parabolic SAR and RSI strategy signals without first checking price action around key price levels such as support and resistance. This can help us to better time our entry whilst filtering out some false signals.
What is the parabolic SAR?
The parabolic SAR (PSAR) is a technical indicator which traders use to attempt to forecast whether a prevailing currency pair trend will continue or reverse. The parabolic SAR indicator plots a curved pattern on a price chart, which describes potential stop and reverse levels.
This technical indictor is very easy to use. If the PSAR is below price, the market is said to be trending upwards. If the PSAR is above price, the market is said to be trending downwards.
Some forex traders also use the PSAR as a trailing stop loss although I find sometimes this can get us taken out of big market moves early. If using the PSAR as a stop loss, I would personally add 10 or more pips as a buffer to avoid getting taking out too early on big trends.
The parabolic SAR is one of a range of trading techniques developed by J. Welles Wilder. His book ‘New Concepts in Technical Trading Systems’ introduced some of the cornerstones of modern technical analysis methods, including the average true range (ATR) and the relative strength index (RSI).
What is the RSI?
If you have any forex trading experience, you have probably come across the RSI indicator. This is a great tool for spotting potentially overbought and oversold market conditions. If the RSI is above 70, the currency pair might be overbought and could reverse at any point. On the other hand, an RSI reading below 30 suggests the market might be oversold and we could expect an RSI reversal to the upside soon.
We can also use RSI divergence to identify the trend direction and momentum. I find that many forex traders overlook this aspect of the RSI indicator, perhaps because they do not know how to read it or think it is too complicated. I think that combing the RSI crossover with divergence can help you get the most out of the indicator and give forex strategies that extra edge.
An RSI divergence occurs when price moves in the opposite direction of the RSI. For a positive divergence, traders would look at the lows on the indicator and price action. If the price is making higher lows but the RSI shows lower lows, this might be considered a bullish signal. And if the price is making higher highs, while the RSI makes lower highs, this could be a bearish signal.
How to trade the parabolic SAR and RSI strategy?
Now we know what both of these indicators do, we can combine them together to get trading signals. All of the different aspects of the indicators must agree for us to consider a trade setup. We will not jump straight into a trade without checking what price action is doing and must always maintain sensible forex money management and trading discipline. I would not want one bad trade to wipe out a run of winners and we shouldn’t let negative emotions such as fear, anger and greed, impact our trading.
When the parabolic SAR is below the price and RSI is around the oversold (30) zone, we will be on the lookout for a buy signal. If the parabolic SAR is above price and the RSI is around the overbought (70) zone, we will look for sell signals. We can also keep an eye on the RSI divergence for additional confirmation and be aware of any candlestick patterns to help with entry timing.
- Parabolic SAR (0.02, 0.2) is below price
- RSI (14) is around oversold zone (30)
- RSI divergence to the upside
- Price moving away from support or breaching resistance
- Bullish price action
In the EUR/USD 1-hour chart below, you will see that we had all of the conditions for a buy trade based on the RSI and PSAR strategy. Price has bounced away from a support level and the PSAR is below price. It looks as though the sellers are losing momentum as confirmed by the RSI falling just below the oversold 30 zone. We have RSI divergence to the upside and a bullish hammer candlestick pattern to time our entry. A stop loss just below the PSAR and support level would have been around 40 pips. This EUR/USD uptrend continued for over 260 pips which provided ample opportunities to take profits along the way. You will also see on the chart a couple of more PSAR signals which could have been decent entries, but not as good as getting in right at the start of this trend.
- Parabolic SAR (0.02, 0.2) is above price
- RSI (14) is around overbought zone (70)
- RSI divergence to the downside
- Price moving away from resistance or breaching support
- Bearish price action
In the EUR/USD 1-hour chart below, you will see that we had all of the conditions for a sell trade based on the PSAR and RSI strategy. Price had formed a significant resistance level that has held up well. The parabolic SAR switched above price suggesting a downtrend which was confirmed by the RSI being around the overbought zone and showing bearish divergence. We also have a large shooting star candlestick pattern to confirm the sell trade. The stop loss could have been placed just above the parabolic SAR and resistance level which is around 40 pips. That’s not bad when you consider this EUR/USD downtrend went for over 340 pips in around 1 week. The PSAR trailing stop loss might have worked well during this move and enabled us to catch the majority of it.
Parabolic SAR and RSI strategy Pros & Cons
- Catch some big forex market trends
- Time entry and exit in direction of trend
- Get into the trend early with actionable signals
- Use on any currency pair and chart timeframe
- Parabolic SAR and RSI indicators are free to use
- Can get caught out in ranging markets
- Takes time to learn how to trade it properly
- There will still be false signals
- Need to have good money management and discipline
Conclusion: is the parabolic SAR and RSI strategy worth trading?
Yes, I think that the RSI and parabolic SAR strategy can catch some god moves as you can see from the EUR/USD trade examples that I have shared on this page. However, it does require confirmation by observing price action and how it reacts around key price levels. I wouldn’t personally blindly take the PSAR or RSI signals as they are without further market analysis.
Not to mention, you will need to have good money management. I would be looking to only take those trade which present a favourable risk to reward ratio, ideally of at least 1:3. Nothing can be more frustrating than seeing one bad trade cancel out a run of winners that you have worked so hard to achieve.
If you like the look of the RSI and parabolic SAR strategy and think that it is something you would like to try, you could always test it out on a demo account to see how things go. You can get a free forex demo account from most forex brokers, including IC Markets who have tight spreads and low fees for trading forex. I would always practice any manual or automated forex strategy on demo at first in order to understand how it works and see if it produces good results before making any commitment.
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