Parabolic SAR is a popular trend following indicator created by Welles Wilder. Our guide will explore how it’s calculated, how it’s interpreted, and more.
- How to Calculate Parabolic SAR
- How to Interpret Parabolic SAR
- How to Change Parabolic SAR Settings
- What are the Right Settings for You?
- Conclusion
What is Parabolic SAR? It’s a trend following indicator countless traders use to set trailing stop losses. This was created by Welles Wilder, who was also known for introducing the well-known Average True Range, Directional Movement (ADX), and RSI in the latter half of the ‘70s. Each of these indicators is still popular today.
Originally, Parabolic SAR was named ‘Parabolic Time/Price System’, while SAR is an acronym for ‘stop and reverse’. Technical analysts usually shorten the name of this indicator to simply ‘SAR’ for maximum convenience.
One of the main reasons this indicator is so common is its simple interpretation: instead of ranges or lines, Parabolic SAR presents information through dots on a chart.
Dots forming below price and ascending in a pattern sloping upwards indicates an uptrend, while those appearing underneath price (and dropping in a downwardly sloping pattern) point to a downtrend.
They might also represent the price at which a trader can put a trailing stop, depending on whether SAR is utilized for this reason.
How to Calculate Parabolic SAR
With Parabolic SAR, values of the previous period are used to create the new calculation, and this can also differ regarding whether SAR rises or drops.
When Parabolic SAR Rises
There are three elements to cover here: the prior SAR, the extreme point (EP) and acceleration factor (AF) — the latter two are indicator-specific values. Let’s take a close look at each:
- Prior SAR is just the previous period’s SAR value
- Extreme point is the prevailing uptrend’s top high
- Acceleration factor begins at .02 and .02 whenever the EP reaches a new high — its top value is .20 regardless of the number of new highs the EP makes
Both the acceleration factor’s rate of increase and maximum value can be changed in the charting platform’s settings.
You can calculate the current SAR value by adding the previous SAR to the product of the prior AF as well as the difference between the prior EP and prior SAR. This is the formula:
Current SAR = Prior SAR + Prior AF * (Prior EP – Prior SAR)
When Parabolic SAR Drops
When looking at the falling parabolic SAR, the three elements remain the same: prior SAR, EP, and AF.
These are combined into the SAR formula in a similar way, but the formula’s second part is subtracted rather than added. So:
Current SAR = Prior SAR – Prior AF * (Prior EP – Prior SAR)
How to Interpret Parabolic SAR
Essentially, the parabolic SAR works like a trailing stop-loss. With uptrends, the SAR is implemented to ‘lock in’ profits (or bring stop-loss nearer to breakeven) on the basis of its placement under price. A lot of traders utilize SAR for stop-loss purposes, so this is mostly its primary application.
When price drops below the SAR level in an uptrend or over SAR in a downtrend, the indicator would reverse. SAR never decreases in an uptrend or increases in a downtrend, and changes with each period continuously, to safeguard profits made on a trade.
Parabolic SAR can also be used as a trend following indicator by itself. Traders choosing to do this would usually bias their trades to the long side if parabolic SAR was at levels beneath price (e.g. in an uptrend).
In a similar way, they could bias their trades to the short side when the parabolic SAR reaches levels over price (e.g. in a downtrend).
However, as with any indicator, this shouldn’t be utilized by itself — it’s best as a complement to alternative tools and modes of analysis.
How to Change Parabolic SAR Settings
Parabolic SAR’s rate of change depends on the AF (acceleration factor), the settings of which can be changed (known as the ‘step’).
The step default is .02, and its standard maximum value is 0.20 (this can be adjusted too). SAR’s rate of change (often known as its ‘sensitivity’) can be changed by lowering the step, which is done by adding more distance between the SAR and price.
SAR would reverse once price touches its level, so when SAR is further from price, you’re less likely to see a reversal in the indicator.
SAR’s rate of change can be boosted by increasing the step: this will move SAR nearer to price, which would make a reversal in the indicator more likely.
Sensitivity would also drop if the maximum was lowered, and it’s easier to attain the maximum when it’s set to lower levels. The calculation would be less likely to change, and less sensitivity would be expected.
What are the Right Settings for You?
This can be difficult to answer. Having a higher step and higher maximum might be best for traders who want tighter stops to defend their profit or limit downside more easily. So, as an example, a trader using settings of .05 for the step and .40 for the maximum would see somewhat tight stops.
These settings might also be helpful for traders using parabolic SAR as a trend following indicator and prefer indicator sensitivity to be higher, making for more regular changes. But for those looking for more accommodative stops to avoid being stopped out prematurely, and to get some space to breathe, it may be best to set a lower step and lower maximum.
Here, setting .01 for the step and .02 for the maximum would lead to loose stops. This setting might be preferred by traders using parabolic SAR for trend following, for keeping track of a wider view of the trend instead of one that oscillates on a more frequent basis (such as one with higher step and maximum values).
Conclusion
Parabolic SAR is often utilized for tracking trends, and serves as a guide to help traders know where to place their stop-loss to limit the downside or defend profits related to their trades. The function of the indicator’s progressive dot configuration is similar to the adjustment of a trailing stop.
The indicator’s settings can be changed from its step and maximum value of .02 and .20 respectively. Anyone who wants to increase their indicator’s sensitivity (which creates more frequent changes in the trend and tighter trailing stops) should boost the step and maximum value.
But for those who want to decrease the indicator’s sensitivity (leading to less frequent changes in the trend and looser trailing stops) should boost both the step and maximum value.
It’s important to check settings carefully, on a security by security basis, to make sure they align with your preferences. There’s no right answer for which is best, which may be why the default settings are used most frequently.
As with all indicators, parabolic SAR shouldn’t be utilized in isolation. Multiple modes of analysis are required to cultivate a complete trading system, such as other indicators and fundamental analysis.
