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How to Trade with Parabolic SAR in the Most Effective Way
Parabolic SAR is a technical analysis indicator developed by Welles J. Wilder. It was first described in Wilder’s 1978 book, New Concepts in Technical Trading Systems. SAR stands for “stop and reverse”, it trails the price action as the time passes. The indicator is positioned below the price when the prices are soaring, and above the price when the prices are falling. The author himself called this indicator the “Parabolic Time/Price System.”
The indicator was developed with the purpose of notifying the trader about possible trend changes. Being a unique indicator with high practical potential, Parabolic SAR should nevertheless be combined with other indicators for maximum accuracy.
How does Parabolic SAR work?
The idea behind the indicator is quite simple. When the price crosses one of Parabolic SAR dots, the indicator is expected to turn around and appear on the opposite side of the price line. Such behavior can be a signal of an upcoming trend reversal or at least a trend slowdown.
Parabolic SAR can predict trend reversals, as illustrated by situations 1, 2, and 3
It can be seen in the picture above that when Parabolic SAR touches the price, the trend changes its direction. This risk-following indicator can be used to estimate optimal entry/exit points, predict the trend direction and forecast future behavior of the price action.
Settings for intraday trading
In order to use Parabolic SAR technical analysis indicator, do the following:
1. Click on the “Indicators” button in the bottom left corner of the screen,
2. Go to the “Popular” tab,
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3. Choose Parabolic SAR from the list of possible indicators,
4. Click “Apply” if you want to use the indicator with standard parameters.
5. Or switch to the “Set Up & Apply” tab and configure the indicator according to your liking.
Traders can adjust two technical parameters in the “Set Up & Apply” tab, which are acceleration and acceleration max. By increasing the numbers, you can make the indicator more sensitive, at the same time sacrificing its precision.
The opposite effect can be achieved by lowering the values of acceleration and acceleration max: the indicator will become less sensitive but will also provide less false signals. Finding the right balance between accuracy and sensitivity is a prime task for traders interested in using Parabolic SAR in intraday trading.
Adjusting the acceleration and acceleration max parameters
How to use Parabolic SAR
According to Welles J. Wilder himself, the indicator should only be used during strong trends, that usually do not exceed 30% of the time. The use of Parabolic SAR on short time intervals and during the sideways movement is not advised as the indicator loses its predictive potential and can return false signals.
The indicator loses its predictive power during periods of low volatility
Professional traders often combine the use of Parabolic SAR with other indicators. One of the possible combinations — Parabolic SAR and Simple Moving Average — and its practical applications are described below. It is advised to double-check Parabolic SAR signals with the help of other indicators.
Parabolic SAR + SMA
The combination of these two technical analysis tools is popular among experienced traders. Parabolic SAR (acceleration = 0.04, acceleration max = 0.4) and the SMA (period = 55) are used together to confirm each other’s signals. When using both indicators at the same time the traders are waiting for the following signals to appear:
Anticipating the bullish trend
When the price is below the SMA and Parabolic SAR demonstrates upward movement, the trend can be expected to become bullish.
Anticipating the bearish trend
When the price is above the SMA and Parabolic SAR demonstrates downward movement, the trend can be expected to become bearish.
It is worth noting that no indicator can guarantee accurate signals 100% of the time . From time to time all indicators will provide false signals, and Parabolic SAR is not an exception. It is your work, as a trader, to tell true signals from false ones.
NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
In accordance with European Securities and Markets Authority’s (ESMA) requirements, binary and digital options trading is only available to clients categorized as professional clients.
GENERAL RISK WARNING
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You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
PARABOLIC SAR & ADX STRATEGY
A simple to understand ‘contrarian’ strategy for binary options trading is using Parabolic SAR and ADX indicators. This is a trend trading strategy for currencies, which uses 5 minute technical charts for analysis and 15-60 minutes expiry times. Watch the video tutorial and learn this simple strategy.
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Parabolic SAR Strategy Rules
Contrarian strategy is a simple trading strategy for binary options trading with currencies (forex). Strategy is useful in trending markets, especially in the periods of longer trends.
5 minute charts are used for technical analysis and trade entries in the direction of the developed trend are made after the pullbacks against the trend. Two indicators (Parabolic SAR and DX) are used to provide the trade signals. Expiry times can be from 15 minutes up to full hour, depending on the speed of market.
Strategy results depend much on market conditions, however up to 15 trades per day can be made with a single currency, achieving avg. 60-70% win rate if applied in trending market.
Strategy is quite flexible and a trader can enter the trades only on the signals provided immediately after the trend direction change, or can enter successive trades in longer trends. The first option will enable lesser number of trades with expected higher WIN/LOSS ratio whereas the second option will enable making a higher number of trades. Each following trade in the developed trend will hold more risk of reversal forming into trend direction change, resulting in potentially unsuccessful trade.
Parabolic SAR Indicator Trading Guide
Parabolic SAR Indicator Trading Guide
The Parabolic SAR indicator is a price AND time based trend-following indicator. SAR stands for “stop and reverse”. The Parabolic SAR is one of the more complex trading indicators when it comes to the underlying calculations but in this article, you will learn exactly what it is that the SAR does.
Furthermore, I encourage all traders to approach their chosen indicators with a similar approach. It is crucial to really understand what your indicators are doing, what causes them to rise or fall and how are the signals calculated. As we have seen in previous articles about the STOCHASTIC or the RSI indicator, it becomes obvious rather quickly that the majority of traders (including books, websites etc) are using those indicators incorrectly.
So let this guide inspire you on what it takes to really understand your trading tools.
Parabolic SAR Basics
The SAR rises below price as long as the price is in an uptrend. The idea behind theParabolicВ SAR is that it signals a trailing stop loss and during an uptrend, the SAR will only rise and never go down – always increasing the protected unrealized profits.
When the price reverses and when the price falls below the SAR (after an uptrend), then the direction changes and the SAR rises above price – acting as a trailing stop for the downtrend.
The screenshot below shows those basics effectively and during the downtrend on the left, the SAR dots were above the price, acting as a trailing stop. The candle marked when the red checkmark highlights the candle where price, for the first time, hit the SAR. When the price hits the SAR, it would lead to a stop hit, and the SAR signals a change in direction.
The Acceleration Factor -ParabolicВ SAR Sensitivity
How close the SAR trails behind the price is a key factor because it determines how sensitive the SAR reacts to price changes. The high the sensitivity, the faster the SAR changes its direction. This can be both good and bad, depending on the objective of the trader. If a trader prefers to get in and out of trades quickly, a high sensitivity shouldВ be chosen. A trader whose objective it is to ride trades for an extended period and remain in trades during (minor) retracements should pick a lower sensitivity.
In most charting platforms, the sensitivity is either called “step” or “increment.
Let’s compare how sensitivity impacts the SAR signals. On the left, we see the default setting of 0.2 for the increment. On the right, I set the increment to 0.4. We can see right away that the SAR on the right is giving more signals and whereas on the left the indicator seems to be smoother, the high sensitivity jumps around a lot. However, we can also see that on the most right candlestick, the price is falling rapidly and whereas the low sensitivity SAR still signals a long trade, the high sensitivity already signaled a change in direction.
Thus, the low sensitivity is good during long and strong trends, but when the direction changes quickly, a low sensitivity could lead to evaporating profits.
Difficulties trading SAR
The SAR does work well in certain conditions but, as all trend following-indicators, it fails during volatile range markets.
The screenshot below shows that the SAR changed directions 5 times during the chosen period. The SAR would have signaled 2 certain losses, 1 good sized profit, and 2 medium sized profitable trades. This might sound ok, but as we all probably can agree, rarelyВ things go as planned and a loss quickly leads to an emotionally driven decision and things go downhill from there. It is, therefore, recommended to approach backtesting or regular chart review from a more pessimistic point of view.
This scenario shows an even worse situation and out of the 6 SAR signals, 5 would have provided losing trades and just one potential profit.
However, this does not mean that the SAR is generally bad indicator or that the signals are flawed. It just means that a trader really needs to know how to use the indicator and when to stay out of the market.
This is pretty much the premise of all trading strategies. Nothing will work 100% of the time and it’s a trader’s duty to understand when his system works and when he does not have an edge.
As with all trading indicators, tools or concepts, they should never be used on their own – generally speaking. It is always advisable to use additional filter tools to improve signal quality.
Let me provide you with a few possible solutions on how to improve the signal quality of the Parabolic SAR.
#1 ADX + Moving average
A popular combination is a moving average together with the ADX. The weakness of the SAR is range markets and that’s why this combination can improve the SAR trading signals potentially.
Here are the two filter layers:
- The ADX is your trend tiebreaker. If the ADX is above 15, you are in a trend. If the ADX is below 15, you are in a range. Thus, a trader would only look for a trade when the ADX is above 15 to avoid range markets that are so dangerous for the SAR.
- The moving average is the directional filter. When the price is above the MA, the trader only looks for potential buy trades. The SAR is his trailing stop loss and he would only re-enter long trades as long as the price is above the MA.
In the screenshot below, there is one trending phase where the ADX is above 15. During this phase, the price is above the moving average. Thus, the trader will stay aside in all other market conditions and only look for potential long entries as long as the price is in the green marked area.
#2 Slow STOCHASTIC
Remember, the goal of the filter tools is to filter out range periods. In the example below, we, thus, chose a slow STOCHASTIC setting (26,3,3). The STOCHASTIC signals strong trending markets when the lines go above 80 or below 20.
In the screenshot below you can see how precise the STOCHASTIC seems to signal trend markets. First, the STOCHASTIC confirms a long downtrend when it dips below 20 and stays there for an extended period. The SAR stop only got hit when the STOCHASTIC also rose above 20.
Afterward, the STOCHASTIC moved in and out of 80 three times. The SAR would have allowed riding the long trades as well. Between the second and the third time, the SAR stop wouldn’t have been hit so that the trader could have stayed in the trade even longer.
The goal of an indicator
When it comes to indicator trading or using any trading tool for that matter, it is important to remember a few key points.
- Indicators indicate
As the name suggests, indicators are not meant to provide signals on their own. Indicators visualize price action data on your charts. Thus, their goal is to provide information only.
- They enhance signal quality
The job of a trader to turn the indicator data into a meaningful trade idea. Amateur traders look for shortcuts and only look for crossovers or surface signals – that’s why amateurs fail because indicators can’t give signals. The professional trader uses the information the indicator provides to come up with an intelligent trade idea and uses other concepts to improve his trading.
- It’s not about a 100% winrate
When you develop an indicator based trading system, most traders make the mistake of optimizing for winrate. However, winrate is often the least important component. Instead, a trader should maximize his profitable trades and find ways to minimize losing positions. This will tilt the Reward:Risk ratio in his favor and provide much more to his positive expectancy, than just looking at winrate.
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