In the trading mechanism, experience will be determined by the trader’s ability to anticipate certain price movements of a particular financial product. Currently, there are indeed many indicators that can be used to predict price movements, but many have proven to be useless.
One indicator that is very easy to interpret is Parabolic SAR, especially for short-term momentum. One of the advantages of this indicator is the level of ease of interpretation. The Parabolic SAR indicator will provide information such as when the market starts to tend to move down or vice versa.
Definition of Parabolic SAR
In general, Parabolic SAR is one of the price indicators in technical analysis that is used by many traders from all over the world to determine the direction of price momentum and the point where this momentum has a higher probability than normal conditions, especially for short-term momentum. While SAR stands for ‘stop and reversal’.
The popular indicator was developed by a technical expert named Welles Wilder, who also created the relative strength index, an indicator that shows a series of points above or below the price movement in a graph. (Also read: Explanation and How to Calculate Leverage)
Parabolic SAR was first introduced by J. Welles Wilder Jr., in his book entitled ‘New Concepts in Technical Trading Systems’. Not only does it function as a reversal indicator, but Parabolic SAR can also be used as a reference to determine the stop loss level or exit point.
The use of Parabolic SAR is known to be very effective in determining the stop level, making this indicator very useful for traders, especially for determining the trailing stop level, a more flexible stop level, and can be changed according to price developments.
Parabolic SAR
As the name itself suggests, namely Parabolic SAR, this indicator resembles a parabola formed by a series of dots. There are two parameters used in the calculation of Parabolic SAR. The first is Step, which is a number that determines the location of the SAR point in relation to the price.
The higher the step number, the more sensitive the indicator will work. That way, the intensity of SAR fluctuations that move up or down the price becomes higher, and results in more errors in making predictions or anticipations.
The second parameter is the Maximum Step, which is a set number to adjust the SAR point to the next price movement. The higher the Maximum Step number, the closer the SAR point is to the next price movement. Indirectly, the lower the number, the further the SAR point or trailing stop will be from the price movement. That is why Wilder recommends that the step and maximum values are 0.02 and 0.2
Using Parabolic SAR
Like other popular indicators, Parabolic SAR will work optimally when the price is in a downtrend or uptrend. However, in sideways conditions, Parabolic SAR sometimes produces failed signals or is usually known as whipsaw.
To overcome this problem, Wilder, the creator of Parabolic SAR, recommends that the use of this indicator must be guided by other trend indicators, so that it can provide more complete confirmation, whether the ongoing trend is adequate, both in terms of direction and quality.
Wilder also said that the trend must first be recognized well, for example by using the ADX indicator, which then takes a position using Parabolic SAR according to the direction of the recognized trend. In general, Parabolic SAR has two important uses:
1. Recognizing Price Trends
The first is to recognize price trends by observing the movement of SAR points or dots that are below or above the price movement. An uptrend can be identified if the price moves above the SAR and while a downtrend is recognized if the price moves below the SAR.
2. Entry and Exit
This use of Parabolic SAR is useful for recognizing entries and exits by observing prices that pass through the upper or lower SAR points. For example, buy when the price passes the upper SAR point, sell when the price passes the lower SAR point, and the Exit or Stop signal appears when the opposite position entry signal occurs.
Parabolic SAR Interpretation
The formula for calculating this indicator is quite complicated, but the interpretation is relatively easy, even very simple. Points below the price movement indicate upward momentum and points above the price movement indicate potential downward momentum.
One aspect that must be considered is the position of these points which will later be used in determining the market position, depending on where they are located compared to the price movement. Points located below the price are interpreted as bullish signals with the expectation that momentum is still in an upward direction. Conversely, points below the price are interpreted as bearish and under control and tend to still move down.
The first entry point for a buy position is when the current highest price range is successfully penetrated, usually the Parabolic SAR will be at the lowest price range level. As the price increases, these SAR points will follow the increase.
The Parabolic SAR indicator will work well in trending market conditions, but can also produce many ‘false’ signals when the price moves sideways. Momentum transfer occurs when the ‘cross over’ between the parabolic points and the price. Momentum will rise and change to downward momentum when the parabolic dots that were previously below the price, change to above the price and vice versa.
Parabolic SAR in Forex
Parabolic SAR is a powerful indicator to provide market entry and exit signals. Buy and sell signals will be generated from the movement of parabolic dots against the price. This indicator can also be used to identify market trends earlier.
However, Parabolic SAR in Forex also has drawbacks when the market is moving in consolidation or sideways. The signals generated cannot be accurate. Therefore, it is recommended to connect Parabolic SAR with other momentum or trend indicators.
If you are a beginner forex trader, then you can use the Parabolic SAR trading strategy to practice investing or trading forex. In a trending market, this indicator is a forex trading indicator that works very well.
The Parabolic SAR strategy in forex trading that we have explained is very basic, so if you want to combine it with other forex indicators, such as moving averages, it is claimed to be able to eliminate false signals that occur when the market moves flat or without direction.
However, it turns out that Parabolic SAR has a drawback, namely the signal responds quite slowly when the price moves so that the open position in the trade will be made after the price moves. Because Parabolic SAR responds quite slowly, the stop loss placement must be in an ideal location.
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