Technical analysis is filled with indicators and patterns that help traders predict the movement of security before it takes place. Many indicators help traders and analysts to determine the direction of the movement by applying various formulas and knowledge of past data. Markets constantly repeat themselves, which is the underlying assumption in developing the parabolic SAR indicator.
Let us discuss the Parabolic SAR indicator in detail; how it works, and the advantages and drawbacks of using this indicator.
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The Parabolic SAR is a trend-following and stop-and-reversal pattern that helps traders identify directions of price movements for any instrument. The primary aim of this indicator is to help identify potential trend reversals and entry-exit points for any underlying security.
This indicator was developed by Welles Wilder in the 1970s, and it works greatly in trending markets. A parabolic SAR indicator is plotted as a series of dots on the charts. When the dots are plotted below the bars, it is a bullish signal, and when they are above, it is a bearish signal for the underlying security.
Unlike MACD, this is a lagging indicator; hence, many traders use it to place their trailing stop-losses at correct levels.
Two things determine the Parabolic SAR indicator's plotting on the chart. One is the Extreme Price, and the other thing is the Acceleration Factor. In simple terms, the EP is the highest high the security has made during a positive uptrend. On the other hand, the Acceleration Factor is always set to 0.02, and it has a maximum value of 0.20. Every time there is a new EP, the acceleration factor increases by 0.02 to accommodate the change.
Trading with Parabolic SAR is simple. Traders often look for times when the indicator’s dots are plotted below the candlestick bar for a bullish movement in the security. The best time for selling is when the dots are placed above the bars, indicating bearish movement in the security.
The most significant benefit of using the Parabolic SAR indicator is that it can provide a clear trend direction in trending markets. It supports price action traders to identify potential entry and exit opportunities.
Whereas the only disadvantage of using this indicator is during sideways markets. In such times, the indicator cannot provide a clear outlook and often results in bad trade opportunities.
To execute successful directional trades, understanding the principles of the Parabolic SAR indicator is essential. Open an account with us today to leverage these indicators and patterns, making profitable trading decisions.