In Forex trading, parabolic stop and reverse (parabolic SAR) is an indicator that attempts to find places where reversals are likely. Traders can use parabolic SAR to find entry or exit points in trades. They can also use it to find stop-loss points.
Parabolic SAR explained
Parabolic SAR was created by Welles Wilder and popularized through his book, New Concepts in Technical Trading Systems. The formula for determining parabolic SAR is:
For an uptrend: Previous SAR + Previous Acceleration Factor * (Previous Extreme Point – Previous SAR)
For a downtrend: Previous SAR – Previous Acceleration Factor * (Previous SAR – Previous Extreme Point)
The Extreme Point is the highest price of the current uptrend or lowest price of the current downtrend. The Acceleration Factor starts at .02 and increases by .02 every time the price makes a new high or low, with a maximum of .20.
This equation produces a series of dots on a chart above and below the price. When the dots are above the price, it means the currency pair is in a downtrend. When the dots are below the price, it means the currency pair is in an uptrend. This makes it easier to spot sudden reversals in trend.
Parabolic SAR example
In the chart above, EUR/USD went into a downtrend in early August, 2018. During this downtrend, the parabolic SAR dots were above the price. However, on August 21, parabolic SAR moved below the price and indicated the trend had reversed. September 10-13, parabolic SAR briefly reversed itself and indicated a downtrend. It then went back to indicating an uptrend from Sept. 14th to 16th. Finally, it showed a reversal signal again on September 27.
How to trade using parabolic SAR
Parabolic SAR can be used to find entry points, exit points, or stop-loss points. To find an entry point using parabolic SAR, wait until this indicator shows that the trend is reversing. If the dots are below the price, go long. If the dots are above the price, go short. To find an exit point, close out a long-trade when the dots are above the price or close out a short trade when the dots are below the price.
To find a stop-loss point using parabolic SAR, place your stop-loss at the exact level where the dot appears. This will allow you to place wider stops during a strong trend and tighter stops during a weaker trend.
Parabolic SAR can help to identify sudden reversals in trend. This can allow traders to find profitable entry and exit points. It can also prevent traders from getting stopped-out too early (or too late) by allowing them to place better stops. For this reason, you may want to consider using parabolic SAR as part of your Forex trading toolbox.