Parabolic SAR

What

The parabolic SAR is a technical indicator that is used by many traders to determine the direction of an asset's momentum and the point in time when this momentum has a higher-than-normal probability of switching directions. Sometimes known as the "stop and reversal system", the parabolic SAR was developed by the famous technician Welles Wilder, creator of the relative strength index, and it is shown as a series of dots placed either above or below an asset's price on a chart.

How

SAR(i) = SAR(i-1)+Acceleration*(EP(i-1)-SAR(i-1))

Where:

SAR(i-1) — is the value of the indicator on the previous bar;

Acceleration — is the acceleration factor, usually 0.02 but not greater than 0.20;

EP(i-1) — is the highest (lowest) price for the previous period (EP=High for long positions and EP=Low for short positions).

The indicator value increases if the price of the current bar is higher than previous bullish and vice versa. The acceleration factor (Acceleration) will double at the same time, which would cause Parabolic SAR and the price to come together. In other words, the faster the price grows or sinks, the faster the indicator approaches the price.

When

One of the most important aspects to keep in mind is that the positioning of the "dots" is used by traders to generate transaction signals depending on where the dot is placed relative to the asset's price. A dot placed below the price is deemed to be a bullish signal, causing traders to expect the momentum to remain in the upward direction. Conversely, a dot placed above the prices is used to illustrate that the bears are in control and that the momentum is likely to remain downward.

The first entry point on the buy side occurs when the most recent high price of an issue has been broken; it is at this time that the SAR is placed at the most recent low price. As the price of the stock rises, the dots will rise as well, first slowly and then picking up speed and accelerating with the trend. This accelerating system allows the investor to watch the trend develop and establish itself. The SAR starts to move a little faster as the trend develops and the dots soon catch up to the price action of the issue. The indicator works extremely well when a stock is trending, but it can lead to many false signals when the price moves sideways or is trading in a choppy market.