Wells Wilder first described the parabolic formula in 1978 in his book “New Concepts in Technical Trading Systems”. Wilder was looking for a system that could capture most of the gain in the trending market without relying on any external methods of retaining income. Parabolic calculations give a series of tracking stops, which, if triggered, signal a trend reversal. Stops are recounted daily (or for each period you use) and become closer as the trend progresses.
What is parabolic SAR?
Parabolic sets moving price stops for long or short positions. Also called an indicator of stops and turns (the full name is “Parabolic SAR” – parabolic stops and turns), a parabolic indicator is best suited for placing stop orders, rather than for establishing a direction of movement or a trend.
This indicator is referred to as a trend indicator. It is a line very similar to a parabola (from where the name of the indicator was derived), which is superimposed on the price chart and based on their relative position (parabolic and chart), conclusions are drawn about the state of the market and its development prospects.
If the price of an asset crosses the Parabolic SAR lines, then the indicator reverses, and its following values are located on the other side of the price. In this “flip” of the indicator, the starting point will be the maximum or minimum price for the previous period. The indicator flip is a signal either about the completion (transition to correction) of the trend or about its reversal.
Wilder recommended first determining the trend and then trading with a parabolic in the direction of the trend. If the trend is up, then you should buy when the indicator moves below the price. If the pattern is down, then you should sell when the indicator moves above the price.
Long position can be closed when the price falls below the line of the technical indicator, and short position can be closed when the price rises above the Parabolic SAR line i.e. you need to track the direction of movement of the Parabolic SAR and keep open market positions only in the direction of the movement. Often this indicator is used as a trailing stop line.
How to trade parabolic SAR?
Parabolic SAR works best during strong trend periods, which, according to Wilder himself, occur approximately 30% of the time. Therefore, the traders must first determine if any trend is present on the market using other indicators, for example, Wilder’s ADX line, and then trade using a parabolic in the direction of the trend.
To configure the indicator, only two variables are set: step and maximum step. The higher the step is set, the indicator will become more sensitive to the price change. If the step is high, the indicator will too often fluctuate above and below the price, making its interpretation difficult enough. The maximum step controls the regulation of the parabolic as the price moves. The lower the maximum step value is set, the farther the stop will be moved from the price.
Wilder recommended setting the step value to 0.02 and setting the maximum step value to 0.20.
The Parabolic SAR indicator is straightforward to use for determining a short-term trend. If the price chart is above the indicator curve, this indicates an uptrend. If the price is below the indicator curve, this shows a downtrend. If the price chart deviates significantly from the indicator line, then chances are that they will come closer together, and the trend may change to the opposite direction, or the market may enter the choppy phase.
It is most convenient to determine the trend at higher periods.
Parabolic SAR trading strategy
Here is an example of a simple Parabolic trading method that includes ADX and it helps to avoid many twitches. The method is, for the most part, the same as Kaufman’s, but it is simpler and relies on Parabolic close stops for exits. It reflects the three essential principles that many traders state to follow when trading: trade in the direction of the trend, control your risk and let winners runs.
Here are the trading rules for long entry:
- Use 18-day ADX. Do not initiate trading when the ADX is below 25.
- You may enter long trade when the ADX starts moving up, +DI line crosses above the -DI line, and the parabolic SAR dots shift position to below the price.
- After opening the trade, use Parabolic stops to exit.
- After exiting, you can re-enter when prices cross Parabola again from the bottom up, assuming that ADX continues to grow and DI shows that the trend is still in effect. This time the parabolic system is used to set the time of entry.
Here are the trading rules for short entry:
- Use 18-day ADX. Do not initiate trading when the ADX is below 25.
- You may enter short trade when the ADX starts moving up, +DI line crosses below the -DI line, and the parabolic SAR dots shift position to below the price.
- After opening the trade, use Parabolic stops to exit.
- After exiting, you can re-enter when prices cross Parabola again from the bottom up, assuming that ADX continues to grow and DI shows that the trend is still in effect. This time the parabolic system is used to set the time of entry.
The method is simple and logical because changing the ADX in the upper direction indicates the beginning of the directional movement. DMI indicates whether this movement is directed up or down. The parabolic system confirms the direction, narrows the accelerating stops that control the risk.
Parabolic SAR conclusion
Developed by Wales Wilder, the Parabolic SAR indicator is a valuable tool in trading in today’s markets. This system is difficult to calculate but quite accessible for use by the average trader. Unlike most methods of analysis, whether technical or fundamental, the parabolic is usually unambiguous – it merely does not have a neutral indefinite position. After the entry into the position has been completed, the parabolic determines where the pivot point and probable exit from it are located.
If you are looking to trade forex online, you will need an account with a forex broker. If you are looking for some inspiration, please feel free to browse my best forex brokers. I have spent many years testing and reviewing forex brokers. IC Markets are my top choice as I find they have tight spreads, low commission fees, quick execution speeds and excellent customer support.
If you are a fan of the Parabolic SAR indicator, then you might want to take a look at the free Parabolic SAR EA that I have developed. It can automatically analyse charts for buy and sell signals based on various Parabolic SAR trading strategies.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.
