Analysts use Parabolic SAR, which stands for 'Parabolic Stop and Reversal,' in trending markets to find entry and exit points into the market. However, this indicator won't help you identify trends, so analysts typically only use it once a trend has already been established.
Parabolic SAR is easier to analyze than to calculate. This indicator appears on a price chart in the form of small dotted lines that form the U-like shape of a parabola and can be used to generate buy and sell signals as well as trailing stops.
In general, in an upward trending market, some analysts recommend buying when the indicator moves below the price. In a downward trending market, some analysts recommend selling when the Parabolic SAR moves above the price. A parabola below the price is generally bullish, while a parabola above is generally bearish.
One of the most popular ways to use Parabolic SAR is as a trailing stop. For example, if you own a stock, you'd put a trailing stop below the current price that would adjust upward should the price continue to climb. If the price begins to decline and reaches the trailing stop, the stop-loss would be triggered and your shares would be sold, protecting your profits from further losses. If the price continues to rise, however, the stop-loss would not be triggered, but would continue to rise in value along with the security's price.
SAR (i) = SAR (i-1) + ACCELERATION * (EPRICE (i-1)- SAR (i-1))
SAR (i-1) is the value of the indicator on the previous bar
ACCELERATION is the acceleration factor
EPRICE (i-1) is the highest (lowest) price for the previous period (EPRICE=HIGH for long positions EPRICE=LOW for short positions).
SAR = (HI.1 - SAR.1) x AF + SAR.1
Wilder's acceleration factor (AF) is 0.02 for the initial calculation. Thereafter the AF is increased 0.02 every period there is a New High made. If a new high is not made, then the AF is not increased from the last SAR. This continues until the AF reaches 0.2. Once the AF reaches 0.2 it stays at that value for all future SAR calculations until the trade is stopped out.
SAR = (LO.1 - SAR.1) x AF - SAR.1
The AF is initially 0.02 and changes by 0.02 intervals until it is 0.2, but the change in the AF is made only after each New Low of a period is made. The AF is never increased above 0.2.
The strategies described in this article are for information purposes only, and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision. Securities are subject to market fluctuation and may lose value.