This refers to a technical analysis strategy that utilizes trailing stop and reverse method in order to determine entry and exit points. It is also defined as a price and time analysis measure used to identify points pertaining to stops and reverses.
Also referred to as a Stop And Reverse method, it was developed by J. Wells Wilder. It was introduced by Wilder in his 1978 published-book titled “New Concepts in Technical Trading Systems.”
According to Wilder, this system follows price making it a trend following indicator. Since it follows price like a trailing stop, it rises continuously when an uptrend is in play.
What this means is that this indicator will provide protection to profits as prices advance. Furthermore, it helps to reduce effects of a stop loss. What you ought to know is that this indicator does not rise in case of a downtrend. As a result, it helps to protect profits on short positions.
How to calculate SAR
Formulae used:
Previous Stop And Reverse – this refers to a value from a previous period
Extreme Point (EP) – highest high of current uptrend. It also symbolizes lowest low of a downtrend
Acceleration factor (AF) – Helps to identify sensitivity of SAR
Note:
AF begins at 0.02. It continuously increases by 0.02 each moment E.P rises in an increasing SAR. In a declining SAR, E.P will fall at 0.02
a. How to calculate an increasing SAR
{Previous S.A.R + Preceding A.F (Previous E.P + Preceding SAR)}=Current SAR
b. How to calculate Falling SAR
Previous S.A.R – Preceding A.F (Previous S.A.R – EP) =Present SAR
How it works in trading?
As a popular technical analysis tool, traders and investors use it with a goal of determining future short term momentum of a security. The good news is that this tool can be implemented with your strategy whether it’s designed for entry or exit points.
As a result of its proper implementation, traders and investors are able to determine where stop orders need to be positioned.
The indicator takes into account that an investor is fully invested at a particular position within a certain time frame. As a result, it is vital for those developing trading systems and day traders who want to earn profits.
Since A.F dictates sensitivity of S.A.R indicator, Step and Maximum Step are used. To decrease sensitivity, Step is decreased which means it makes a reversal less likely. On the other hand, to increase S.A.R sensitivity, all you have to is to increase Step.
This will result in the indicator moving closer to price action making a reversal likely.
Final Thoughts
What you ought to know is that a Parabolic-indicator is a great technical analysis tool that provides useful information which helps to determine likelihood of reversals.
Furthermore, it helps traders and investors to implement perfect entry and exit points. That is why it’s a good idea to use it when measuring stability of a trend.