Parabolic SAR (Stop and Reverse)- Technical Indicators -ForexAbode.com
SAR (Stop and Reverse) Indicator for Technical Analysis in Forex Trading:
The SAR or Parabolic SAR was developed by J. Welles Wilder.
SAR is commonly used technical analysis indicator to signal when to stop and reverse the trade position for a currency pair in Forex trading.
SAR works good when there is a strong uptrend (bullish market) or strong down-trend (bearish market). It does not work well when the market is running sideways i.e. in ranges.
(please note that like other technical analysis indicators the use of SAR is not limited to Forex trading. ForexAbode.com, being a Forex exclusive site, would talk in terms of only Forex trading).
How does Parabolic SAR looks like:
When you select SAR on your Forex trading platform chart, you will see dots above and below the chart. Please see the chart below:
In the candle stick Forex chart above (Fig 1) you will see green dots appearing when prices is moving up and red dots when there price is falling down. Please note that the default colors for Parabolic SAR indicator on your Forex trading platform’s chart may be different and can be set as per your choice.
The first green dot below the currency pair's price chart appears when Parabolic SAR confirms upward movement and then with every price move subsequent green dots will appear. Similarly the red dot over the chart appears when SAR confirms downward price movement and then with every price move subsequent red dots will appear. The dots in the same direction keep on appearing till a reversal of the trend is confirmed and not before Parabolic SAR confirms the reversal of the trend.
When the price of the currency pair is moving up and you have a long position (bought the currency pair), follow Parabolic SAR green dots (dots below the chart). When the green dots hit the chart, SAR signals to exit your trade or for entering a trade in reverse position (short-sell), expecting that market may start going down.
When the price of the concerned currency pair is going down and you have a short position (short-sold the pair), follow SAR red dots (dots above the chart). When the red dots hit the chart, SAR signals to exit the forex trade or for entering a trade in reverse position (buy the pair), expecting that market may start going up.
Parabolic SAR can also be used for putting trailing stops for your forex trade i.e. You may consider placing your stop at the levels of appearing dots below the chart when currency pair's price is moving up and at the dots above the chart when the price is going down. “Trailing stops” means moving your stop-loss level upwards when the prices are moving up and moving your stop-loss level downwards when the market is going down. Using trailing stops in Forex Trading is good as it continuously reduces the risk in trading. This will be explained below.
How to use Parabolic SAR Indicator for Technical Analysis in Forex trading (currency trading):
In the Forex chart in Fig 2 above, Points A, C, F, H and I are the points where the falling SAR (red dots) intersected the candle stick chart. The price for the currency pair before these points was going down and had just started going up.
Points B, D, E and G are the points where the rising SAR (blue dots) have intersected the chart. The price for the currency pair before these points was going up and had just started going down.
Point A indicates the stop and reversal when, earlier, we might have entered the market for a short position (short-sold), when the market was been bearish. We will not talk about point A because the down-trend before point A is not visible in this chart.
Point B: There was a uptrend starting at point X. The currency pair price was going up. Suppose we had entered the market for a long position near point X. The price increased and we are in for a profitable trade. The price moved till point P and suddenly it started dropping. We would stay in the trade because the falling prices might be a short term correction i.e. when the price fall slightly and start moving again. But at point B, the rising SAR dots hit the chart. Well, this signaled an exit as SAR confirmed that a reversal in the direction has taken place. What would have happened if we would not have closed our position at point “B”? The prices kept falling till the small horizontal red line below point “C”. We would have ended up at much less profit if you would not have closed your position at point B.
There can be an argument that the prices have gone up again after falling to the horizontal small red line. But then its always better to play safer in forex trading as cutting the losses is equally important as making profits.
Suppose at point “B” we come out from the long position and reverse take another short position i.e. we short sell the currency pair to make a profit if it falls further. Well, at point “C” the falling SAR line (red dots) intersected the chart. This point “C” signaled a “Stop and reversal” again. In such situation we come out of our short position by taking a profit and may enter a long (buy) position. If we did that, then we entered another trade as the price started moving up after that point. We then come out of this long position at point D. Point “D” did not prove to be a good signal but then playing safe may always be better. After point “D” the price moved up again and next signal to come out was at point E. If we did not come out at either point “D” or “E” then we would have ended up at a loss instead of profit as the prices fell down to the point R.
You may check all other points in the Forex chart in Fig 2 to see how those SAR forex trading signals worked.
Having training stops is one of the very important strategies for profitable Forex trading.
Trailing Stops in Forex Trading:
During uptrend: Moving stop-loss level upwards from previous levels when the currency pair's price moves up and we are in long position.
During downtrend: Moving stop-loss level downwards from previous levels when the currency pair's price moves down and we are in short position.
In simple words suppose we buy USD/JPY when 1 USD = 100 JPY. We are certain that the price is going to go up. In case the price goes down, instead of going up, we put a stop-loss order at 1 USD = 99.50 JPY.
As per the expectation and analysis, the currency pair (in this case USD/JPY) price start going up. The price reaches 1 USD = 100.50 JPY. We are still expecting that the price will still go up further. At this point suppose we move the stop loss order from the previous 1 USD = 99.50 JPY level to 1 USD = 100.10 JPY. Now in case the analysis goes wrong and price falls heavily, we still come out with some profit instead of loss.
Parabolic SAR may help in knowing the levels for moving the stops up and down.
We could move the stop positions from one dot to the next dots. In the above Forex chart in Fig 3, suppose we enter the long position at Point A with a Stop Order at X. The prices moves up and we move our stop from X to Y, following SAR green dots (rising SAR), we cut down our chances of losses.
We explained Parabolic SAR in the context of Forex Trading but the same stands good for stock trading or any commodity trading.
