A BRIEF GLANCE ON PARABOLIC SAR
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The Parabolic SAR was developed by Welles Wilder, indicator used to describe the price direction of a stock, as well draw attention to when the price direction is changing.
The parabolic SAR attempts to give trades an edge by highlighting the direction an asset is moving, as well as providing entry and exit points.
The Parabolic Stop and Reverse indicator combines price and time components in an attempt to generate potential buy and sell signals. The Parabolic SAR advertises itself as an effective tool to determine where to place stop loss orders.
Calculation of SAR is complex with if variables that make it difficult to put in a spreadsheet. These examples will provide a general idea of how SAR is calculated. Because the formulas for rising and falling SAR are different, it is easier to divide the calculation into two parts. The first calculation covers rising SAR and the second covers falling SAR.
a) A trader might buy when the price closes above the upper Parabolic SAR. When the Parabolic SAR changes from being above price to below price, then the trader might "stop" and buy to cover their existing short sell and "reverse" direction and buy to go long.
b) A sell signal is potentially generated when the price closes below the lower Parabolic SAR. At the time that the Parabolic SAR changes from being below price to being above price, the trader might "stop" and sell to exit their existing long trade and "reverse" direction and sell to go short.
c) As the price of a stock rises, the dots will rise as well, first slowly and then picking up speed and accelerating with the trend. The SAR starts to move a little faster as the trend develops and the dots soon catch up to price.
The Bottom Line
The parabolic SAR is used to gauge a stock's direction, and for placing stop loss orders. The indicator tends to produce good results in a trending environment, but produces many false signals and losing trades when the price starts moving sideways. To help filter out some of the poor trade signals, only trade in the direction of the dominant trend.
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