Parabolic SAR (Stop and Reverse) is a technical analysis tool used to determine the price direction of a financial instrument, such as a stock, commodity, or currency pair. It was developed by J. Welles Wilder, Jr. and is designed to help traders set stop-loss orders and exit positions.
The Parabolic SAR uses a series of dots above or below the price of an asset to indicate the trend. The dots are placed above the price when it is trending downwards, and below the price when it is trending upwards. The distance between the dots and the price increases as the trend continues, indicating increasing momentum.
The Parabolic SAR also helps traders set stop-loss orders by trailing the stop loss order based on the dots. For example, a trader may set a stop loss order just below the most recent dot when the price is in an uptrend, and just above the most recent dot when the price is in a downtrend.
The Parabolic SAR is calculated using the previous period’s data and a set of predetermined parameters. The calculation involves finding the extreme high and low prices of the previous period, as well as the acceleration factor, which is a value that increases as the trend continues. The acceleration factor is typically set to 0.02, and increases by 0.02 each time a new extreme price is reached.
As an example, let’s consider the case of a hypothetical stock XYZ. Suppose the Parabolic SAR is plotted on a daily chart with an acceleration factor of 0.02. If the price is in an uptrend, the dots will be below the price and will move up as the price continues to rise. If the price then starts to fall and reaches the level of the most recent dot, a trader may set a stop loss order just below that dot. This helps the trader to limit their losses in case the price continues to fall.
The Parabolic SAR can be a useful tool for traders to identify the direction of the trend and set stop-loss orders. However, like any technical analysis tool, it should not be used in isolation and should be used in conjunction with other indicators and fundamental analysis to make informed trading decisions.
