Parabolic SAR

Celticheart Investor

A beginner's guide to trading and investing

The Parabolic SAR (Parabolic Stop and Reverse) was created by J. Welles Wilder and is used to identify probable directional changes in trends (up or down) in any given commodity, which in this case we will apply to the topic in hand, namely share prices.  

Unlike other indicators each trend is calculated almost independently of each other. When the share price is in an uptrend, the Paraabolic SAR starts below the price and curves upwards towards it. When in a downtrend, the Parabolic SAR starts above the share price and curves downwards. The Parabolic SAR is always calculated one day ahead with tomorrow’s SAR value created using the data available today.


Just like the previously discussed Moving Averages, SAR is a trend following indicator although in some ways it can be seen as a predictive tool, useful for setting a trailing stop loss or to identify an appropriate buy or sell (entry or exit) point . The system is based on prices tending to stay within a parabolic curve (Parabola) during a strong trend in either direction (uptrend or downtrend). It is probably fair to say that this particular technical analysis tool lends itself more towards short term traders than mid to long term investors simply because of the speed at which it functions.

http://en.wikipedia.org/wiki/Parabolic_SAR
http://en.wikipedia.org/wiki/Parabola


This particular indicator works best when there is a clear up or down trend, and as such is much less reliable when a share is being particularly volatile or is moving laterally. For this reason it is recommended that the Parabolic SAR is used in conjunction with your other indicators.

J. Welles Wilder also recommended firstly using the Parabolic SAR to identify a change in direction of any given trend, and then to use other indicators to determine the strength of that trend.


The parabolic SAR is is used by many traders to identify the probable point at which the trend will change direction, generally referred to as a reversal, which is why it has the suffix SAR (Stop and Reversal).

In simple terms a dot positioned below the share price is regarded as being bullish indicating that the share will remain in an uptrend, whereas a dot positioned above the share price is bearish indicating that the downtrend will continue.

As the share price rises, the dots will rise as well, accelerating with the trend which allows the trader to track the development of the trend. As the trend develops the Parabolic SAR accelerates until it catches up with the current share price.

 
Below is a sample chart showing both downtrend and uptrend SAR patterns, shown as red dots for the downtrend, (always above the share price) and green dots for the uptrends (always below the share price). I have deliberately left the MACD, Fibonacci numbers and MA 20/50 on the sample chart as it is important to see how the Parabolic SAR relates to them. Note how the start of the last uptrend coincides with the MA20 crossing the MA50 and also the MACD rising above the zero line.

You will note that the chart has been kept anonymous as it seems that when I use live chart samples some people make the assumption that I am ramping or de-ramping that particular share (a topic I will be addressing very soon).

Next time:  Relative Strength Index (RSI)

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.