4.35 How to Use Parabolic SAR
How would you like to have an indicator that would tell you when to get on, and more importantly, when to get off? We mean an Forex pair to trade, silly!
Also, would you like it be very, very easy to use?
Also, no math at all?
Yes. Yes. And yes!
(OK, there’s a lot of horrendous math involved, but nobody, at least no trader goes into it, we promise, and we’ll just let our computers do the hard work at our bidding.)
Parabolic SAR. Yup, that’s the name of the indicator. SAR as in ‘stop-and-reverse’. Parabolic? Well, the dot's form in the shape of a parabola at times. Let’s look at the chart below.
Did you notice the series of dots appearing above and below the price bars? Those are the dots placed by the Parabolic SAR indicator.
See how, in a downtrend, the dots are placed above the price bars and when the price is going up, they appear below the candles. The dots shifted their position when the trend reversed.
At the first hint that an uptrend may be emerging, the first dot will appear below the price action, a bit of more confirmation will bring the second dot and so on. Similarly during a downtrend the dots will start appearing above the price-action chart.
So, what’s the big deal you may ask? As I said, this one is very simple – when the dots are below the price line, you ought to be buying, and when they are above - you should be in sell mode.
Trading with Parabolic SAR
Easy! Enter a buy trade when the Parabolic SAR changes from above the price line to below it, BUT, to ensure that you are entering a valid trend, put in the buy order only when at least three dots form in succession. This way you filter out fake out moves and improve your chances of a winning trade.
Similarly, bail out of a long trade when the Parabolic SAR changes from below the price line to above it. Again, wait for three dots in succession for confirmation.
For sell trades and their exit, just follow the mirror reverse of the above procedures for long trades. The above chart says it all.
Another way of entering a trade is when the line of dots hit the price-action chart. However this strategy should be avoided when the trend is strong. Let's check it out:
- When the dots of parabolic SAR are below the price bars, indicating an uptrend, wait for a correction to start taking place. When the dots hit the falling bars, it's an indication that the downward movement may gather momentum and you may go for short-selling.
- Similarly when the parabolic SAR is above the price bars during a downtrend, you may take a long position when the dots hit the price chart during an upward correction.
Please note that this "dots hitting the chart" situations can also be used to exit any existing trades taken in the direction of the existing trend.
When to Use?
Well, lets have a look on following two Forex charts - one with a strong trend and one showing the parabolic SAR in a choppy market, without a clear trend.
During a Strong Trend
When There is No Trend
As the above charts show quite clearly, just one point of caution – the Parabolic SAR works best in markets that are in good trends. Range-bound markets will deliver whipsaw trades, losses and bad tempers!
- How to Use Parabolic SAR