Introduction – What’s the Parabolic SAR indicator?
The Parabolic Stop-and-Reversal (SAR) indicator is a trend detecting indicator which is used showcase entry and exit points on a price path. The indicator is represented as dots which appear under or above the candlesticks. Dots located below the price candles are seen when the market is rising, but are located above the candles when the market is falling.
The indicator gets its name from the trailing action it performs on the price until a time when the trend stops and begins to reverse. The Parabolic SAR is classified as a trend indicator and is listed on the AG Markets MT4 as such. In order to access the Parabolic SAR, click on “Insert”, then “Indicators”. This releases a drop-down menu which displays the Parabolic SAR among other trend indicators. Click on it to attach it to the price chart.
How to use the Parabolic SAR in forex trading
The Parabolic SAR can be used in forex trading in several trend trading scenarios. When the positioning of the dots that make up the Parabolic SAR change, then this signals a trend change, so this can be used in this instance in new trend determination. This function has to be complemented because as a leading indicator, the Parabolic SAR shows a lot of false signals.
That is not all. The Parabolic SAR is one of the tools in forex which can be used as a trailing stop. It can also be used to create entries and exits.
Trend Trading with the Parabolic SAR
When the dots of the indicator are seen below the candles, this is an indication to buy. When located above the candles, the dots of the Parabolic SAR are an indication to sell. By having its dots appear sequentially above and then below the candles, the Parabolic SAR is performing a trend-detection function. However it is a leading indicator and so generates a lot of false signals in performing this action. Therefore, the Parabolic SAR must be combined with indicators or with information from the charts that provides a filter to weed out most of the misleading signals. A price chart that displays the Parabolic SAR indicator will show the dots of the indicator on the candlesticks, showing selling and buying signals in a sideways market. Buying or selling at this point is an invitation to failure.
As a Trailing Stop
The Parabolic SAR can be used as a trailing stop because as price advances or retreats, the dots of the indicator trail the highs and lows by several pips. The Parabolic SAR has an advantage over conventional trailing stops in the sense that they are dynamic. The dots that make up the Parabolic SAR do not catch up with the price action. Either they trail the current trend, or they suddenly appear on the other side of the candle indicating a trend change. So, the trader prevents the stress of trying to determine where to start trailing the market; simply apply the Parabolic SAR, detect the pip distance between the candle high/low and the Parabolic SAR dot, and use this to set the trailing stop.
The example below is used to illustrate two possible ways to use the Parabolic SAR indicator as described above. The snapshot above shows a trendline on which the price has formed 2 pinbars. The Parabolic SAR signal here is to enter a BUY order (dots under the candles). The trend line and the pinbars give confirmation to the signal of the Parabolic SAR. As price moves along in an upward manner, notice that the distance between the candle low and the Parabolic SAR starts to widen. The trailing stop is set at the region of the dot (lower blue horizontal line). The long trade is closed when the Parabolic SAR changes its position relative to the candles (in this example, from below the candle to above the candle).