Parabolic Stop And Reversal (Parabolic SAR)
Parabolic Stop and Reversal is also known as Parabolic Time/Price indicator. Parabolic SAR was developed by Welles Wilder, which is used to set trailing price stops (Achelis 1995).
Please remember that Parabolic SAR is not a momentum indicator (Pring 2002).
How to set trailing price stops
There are two variables: (1) step and (2) maximum step.
The higher the step is set, the more sensitive the indicator will be to price changes. If the step is set too high, Parabolic SAR will fluctuate above and below the price too often. This will make the interpretation difficult. The maximum step controls the adjustment of Parabolic SAR as the price moves. The lower the maximum step is set, the further the trailing price stops will be from the price.
Wilder recommends setting the step at 0.02 and the maximum step at 0.2.
In a rising market, the stop is continually being raised, never lowered. In a declining market, the opposite will hold true (Pring 2002).
How to interpret
Close long positions when the price falls below Parabolic SAR and close short positions when the price rises above Parabolic SAR (Achelis 1995).
The chart for Tat Hong shows how Parabolic SAR can catch most trends and allow the trader to profit from the buy/sell signals. A buy signal is given when the upper Parabolic SAR crossed the price line (blue arrows); whereas a sell signal is given when the lower Parabolic SAR crossed the price line (red arrow).
Since it is a stop-loss system, Parabolic SAR can be used with any momentum indicators, once that indicator has been used to filter out a good entry point for a trade (Pring 2002).
According to Pring (2002), it is preferably to use Parabolic SAR as a stop system only, and not a stop and reverse system.
Parabolic SAR works best during strong trending periods, which Wilder estimates occur roughly 30% of the time. Therefore, investors may first want to determine if the market is trending by using other indicators.
The reason why Parabolic SAR does not work well in a trading range is because it is unable to gather sufficient momentum to quickly reduce the risk (Pring 2002).
- Achelis, S. B., Technical Analysis from A to Z, 1995
- Pring, M. J., Technical Analysis Explained, 2002