Parabolic SAR Indicator ExplainedThe parabolic SAR (Stop and Reverse) indicator is a tool used in trading that helps to show when to buy or sell a stock. It looks like a series of dots on a graph that follow the direction of the stock price.
When the dots are below the stock price, it means you should buy the stock. When the dots are above the stock price, it means you should sell the stock. The dots move closer to the stock price as time goes on, and they can help you decide when to get in or out of a stock.
Think of it like a game of "hot or cold." When the dots are far away from the stock price, it's like you're far away from finding the right answer. As the dots get closer to the stock price, it's like you're getting warmer and closer to the right answer. When the dots are right on top of the stock price, it's like you've found the answer and you should either buy or sell the stock depending on whether the dots are above or below the stock price.
💠Trend following: One common trading technique is to use the parabolic SAR indicator to follow trends. When the dots are below the stock price, it indicates an uptrend, and when the dots are above the stock price, it indicates a downtrend. Traders can use this information to enter long or short positions accordingly, with the goal of profiting from the trend.
💠Stop loss placement: Another way to use the parabolic SAR indicator is to set stop loss orders. When a trader enters a long position, they can place a stop loss order below the parabolic SAR dot. Similarly, when entering a short position, a stop loss order can be placed above the parabolic SAR dot. This helps to limit potential losses if the trade goes against the trader.
💠Reversal trading: The parabolic SAR indicator can also be used to identify potential trend reversals. When the dots change position from above to below the stock price, it indicates a potential reversal from a downtrend to an uptrend. Similarly, when the dots change position from below to above the stock price, it indicates a potential reversal from an uptrend to a downtrend. Traders can use this information to enter positions in the opposite direction of the previous trend, with the goal of profiting from the reversal. The start of the downtrend or uptrend levels can also be used to indicate stronger directional changes
Remember that no trading technique is foolproof, and it's important to practice risk management and to have a solid understanding of the market before trading with real money.
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How the parabolic SAR is calculated :
The calculation of the indicator is based on two main factors: the price of the stock and the acceleration factor (AF).
The AF is a starting value of 0.02 that increases by 0.02 every time the price reaches a new high (or low) until it reaches a maximum value of 0.20. The AF is used to increase the speed at which the parabolic SAR moves closer to the price.
The calculation of the indicator is done in two steps:
Finding the first parabolic SAR value: The first parabolic SAR value is equal to the lowest low of the stock over the past "x" periods, where "x" is the length of the period used in the calculation. This value is used as the starting point for the indicator.
Updating the parabolic SAR value: After the initial value is found, the indicator updates each period based on the previous period's parabolic SAR value. The formula for updating the parabolic SAR value is:
Parabolic SAR (n) = Parabolic SAR (n-1) + AF *
Where:
-Parabolic SAR (n) is the value of the indicator for the current period.
-Parabolic SAR (n-1) is the value of the indicator for the previous period.
-EP (Extreme Point): EP is the highest high or lowest low of the current trend, depending on whether the trend is up or down. It is used in the calculation of the parabolic SAR value for the next period.
