How To Using Parabolic SAR Indicator to Trade Stock & Binary Options

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How to use Parabolic SAR Indicator to Trade Stock & Binary Options

The Parabolic SAR indicator (or PSAR) is designed to calculate the point in time when there emerges a better than average probability of a trend switching directions.

Developed by Welles Wilder, a famous technical trader who also created the RSI indicator, the Parabolic SAR is easy to understand and is used by many traders to predict when a trend will reverse.

Visual Representation of the Parabolic SAR

On a chart, the Parabolic SAR indicator is displayed as a series of dots positioned either above or below the asset’s price. A dot below the price indicates a bullish trend while a dot above the price indicates bearishness.

Stops and Reversals

A trading signal is generated whenever the series of dots reverse positions. A buy signal is generated when the dots shift from above the price to below the price. A sell signal is generated when the dots move from below the price to above the price. Traders typically wait for two or more dots to crossover before confirming the signals.

PSAR Parameters

The parabolic SAR indicator only has two parameters. They are the Acceleration Factor or AF and the maximum AF.

The Acceleration Factor affects how sensitive the PSAR indicator is to the underlying price fluctuations. The higher the AF, the more sensitive the indicator which translates into higher frequency of buy or sell signals being generated while simultaneously also reduces the strength of these signals.

Typically, the AF is defaulted to 0.01 for stock trading and 0.02 for currency trading. Maximum AF is usually set at 0.20.

Continue Reading.

RSI (Relative Strength Index) Indicator Explained

The RSI or Relative Strength Index indicator is bounded momentum based technical indicator that attempts to predict a change in momentum. . [Read on. ]

MACD Indicator Explained

MACD (usually pronounced Mac-Dee) stands for Moving Average Convergence Divergence. The MACD indicator gives the short to medium term trend of the price action. [Read on. ]

Bollinger Bands Explained

The bollinger bands are adaptive trading bands that reflect changes in volatility and provide a better view of the true extent of the price action. [Read on. ]

Parabolic SAR Explained

The Parabolic SAR indicator (or PSAR) is designed to calculate the point in time when there emerges a better than average probability of a trend switching directions. [Read on. ]

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ADX Indicator Explained

The ADX, or Average Directional Index measures the strength of a trend and can be useful to determine whether an asset is currently in a trending market or a ranging market. [Read on. ]

Using the Parabolic SAR with Binary Options

The parabolic SAR is an indicator that is commonly used by binary option traders to determine trends and movements in price. SAR stands for “stop and reverse” and was created by Welles Wilder, a famous technical analyst. It is relatively simple to use and often becomes a main component to a traders overall strategy. It provides a great visual representation of the overall direction of the market and makes for a clear and easy to use indicator.

How It Works

The parabolic SAR is graphed on a trading chart by plotting small dots above or below the price. If the dots are below the candlesticks, this signals a bullish sentiment in the market and traders should look for opportunities to buy. On the other hand, if the dots are above the candlesticks, this represents a bearish sentiment in the market. In this case, traders are looking for a decline in price and chance to sell the underlining asset. This indicator is very mechanical in nature. It is important to note that this indicator assumes that the market is always moving either up or down and that the trader is fully invested in either a long or short position. You can view a chart with the parabolic SAR indicator applied to it below.

Traders should look to enter positions when the parabolic SAR shifts from below to above the candlesticks price or vice versa, depending on the sentiment in the market. If used on a 5-minute chart, this can provide a good opportunity for binary options that are expiring within an hour or even a shorter amount of time. Again, this indicator does a great job at signaling short term trends, so it works well with options that do not have much time left to expire.

When to Use

This indicator can be very useful within certain market conditions. It is generally most reliable when the market is trending in one direction. This is because the SAR is designed to find the security’s general trend and follow it like a trailing stop. It works in both uptrend as well as downtrend and should be used to help a trader find entry and exit points within those trends. Look at this indicator being used on a 5-minute trading chart below. It can provide many trade signals so that a trader can constantly have money at work. Even though this can be a powerful tool for a trader, it should never be used solely on its own. It is most efficient for trading binary options when combined with other indicators.

When Not to Use

This indicator is least advantageous when the market is ranging in price. This is represented when the dots are appearing both above and below candlesticks consecutively on a chart. A picture of this kind of situation can be found below. This often causes false buy or sell signals and can portray an inaccurate picture of the direction that the market is moving in. This also is a signal of lack of volatility in the underlining market which is bad for placing short term binary option trades. Take a look at a ranging market.

Conclusion

The parabolic SAR is an important component to any binary option trading strategy. When used in the ways mentioned in this article, it can give a trader the ability to spot short term trends and price movements. Remember that using this indicator along with other trading tools will give insights on the direction the market is moving.

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,

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.

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How Is the Parabolic SAR Used in Trading?

What Is the Parabolic SAR?

The parabolic SAR, or parabolic stop and reverse, is a popular indicator that is mainly used by traders to determine the future short-term momentum of a given asset. The indicator was developed by the famous technician J. Welles Wilder Jr. and can easily be applied to a trading strategy, enabling a trader to determine where stop orders should be placed. (The calculation of this indicator is rather complex and goes beyond the scope of how it is practically used in trading.)

Understanding the Parabolic SAR

One of the most interesting aspects of this indicator is that it assumes a trader is fully invested in a position at any point in time. For this reason, it is of specific interest to those who develop trading systems and traders who wish to always have money at work in the market.

The parabolic SAR indicator is graphically shown on the chart of an asset as a series of dots placed either over or below the price (depending on the asset’s momentum). A small dot is placed below the price when the trend of the asset is upward, while a dot is placed above the price when the trend is downward. As you can see from the chart below, transaction signals are generated when the position of the dots reverses direction and is placed on the opposite side of the price.

As you can see from the right side of the chart, using this indicator by itself can often lead to entering/exiting a position prematurely. So, many traders will choose to place their trailing stop loss orders at the SAR value, because a move beyond this will signal a reversal, causing the trader to anticipate a move in the opposite direction. In a sustained trend, the parabolic SAR is usually far enough removed from price to prevent a trader from being stopped out of a position on temporary retracements that occur during a long-term trend, enabling the trader to ride the trend for a long time and capture substantial profits.

Markets and the Parabolic SAR

The parabolic SAR performs best in markets with a steady trend. In ranging markets, the parabolic SAR tends to whipsaw back and forth, generating false trading signals. Wilder recommended augmenting the parabolic SAR with use of the average directional index (ADX) momentum indicator to obtain a more accurate assessment of the strength of the existing trend. Traders may also factor in candlestick patterns or moving averages. For example, price falling below a major moving average can be taken as a separate confirmation of a sell signal given by the parabolic SAR.

Parabolic SAR

Parabolic SAR is a trend following indicator and is also popularly used among traders to set trailing stop losses.

The indicator was developed by Welles Wilder, who also developed and introduced the Average True Range, RSI, and Directional Movement (ADX) to the public in the late 1970s. All of these indicators remain widely popular today.

Parabolic SAR was originally named “Parabolic Time/Price System” with SAR an acronym for “stop and reverse”. Technical analysts often refer to the indicator as simply “SAR” by itself.

Part of the indicator’s popularity stems from its easy interpretation. It is distinct in that instead of lines, ranges, or “clouds” it uses dots to convey information on the chart.

Dots that form underneath price and are rising in an upwardly sloping pattern suggest an uptrend. Dots that form above price and are falling in a downwardly sloping pattern suggest a downtrend. They may also represent the price where a trader could place a trailing stop, depending on whether SAR is used for this purpose.

Parabolic SAR plotted on a daily chart of the S&P 500

Calculation of Parabolic SAR

Parabolic SAR uses values of the previous period to come up with the new calculation. The calculation also differs regarding whether SAR is rising or falling.

Rising Parabolic SAR

In general, we have three elements – the prior SAR, and two indicator-specific values known as the extreme point (EP) and acceleration factor (AF).

Prior SAR is simply the SAR value of the previous period.

Extreme point (EP) is the highest high of the prevailing uptrend.

Acceleration factor (AF), under the indicator’s default settings, starts at .02 and increases by .02 whenever the extreme point (EP) makes a new high. Its maximum value is .20 regardless of how many new highs are made by the extreme point.

The acceleration factor value – both the rate at which it can increase and its maximum value – can be adjusted in the settings of the charting platform.

In the SAR calculation formula, the current SAR value is calculated by taking the prior SAR and adding it to the product of the prior acceleration factor and difference between prior extreme point and prior SAR:

Current SAR = Prior SAR + Prior AF * (Prior EP – Prior SAR)

Falling Parabolic SAR

The three elements stay the same – we use prior SAR, extreme point (EP), and acceleration factor (AR).

They are combined into the SAR formula very similarly, just that instead of adding the second part of the formula, it is subtracted instead.

Current SAR = Prior SAR – Prior AF * (Prior EP – Prior SAR)

Interpretation of Parabolic SAR

The parabolic SAR effectively operates like a trailing stop-loss. In uptrends, the SAR works to gradually “lock in” profits (or pull the stop-loss closer to breakeven) on the basis of its position below price. Many traders use SAR for stop-loss purposes and is largely its primary use.

For example, if we’re trading the daily chart of the S&P 500 and are currently long the market, we could set our stop-loss equal to the price level dictated by the SAR.

Depending on the trend, the SAR can be near or far from price. On this particular 15-minute chart of the S&P 500, SAR is less than one point (or under 0.04%) away from price, making a triggering of the stop-loss fairly likely.

Overall, this stop-loss will continue upward so long as the uptrend is in place. Once price breaks below the SAR level in an uptrend or above SAR in a downtrend, the indicator will reverse.

Accordingly, we never see SAR decrease in an uptrend or increase in a downtrend and continuously shifts with each period to protect any profits made on a trade.

Parabolic SAR can also be used as a trend following indicator in its own right. Traders using it in this sense would normally bias their trades to the long side when parabolic SAR is at levels below price (i.e., in an uptrend). Similarly, they might bias their trades to the short side when parabolic SAR is at levels above price (i.e., in a downtrend). But like all indicators, it should not be used in isolation and used alongside other technical tools and modes of analysis.

Adjusting the Settings of Parabolic SAR

The rate of change in parabolic SAR is dependent on the acceleration factor (AF), hence its designation as such. The settings of the AF can be adjusted, called the step.

The default for the step is .02. Its maximum value is 0.20 by default and is also adjustable.

SAR’s rate of change, sometimes called its sensitivity, can be altered by lowering the step. This works by increasing the distance between SAR and price. SAR reverses once price touches its level. Therefore, if SAR is further from price, a reversal in the indicator is less likely.

Take a look at this example of the daily chart of the S&P 500 using the standard settings (.02 step, .20 maximum).

And let’s compare this to different settings of a .01 step and .20 maximum.

We can see that the trend is less likely to shift back and forth.

Contrarily, SAR’s rate of change can be increased by increasing the step. This moves SAR closer to price, making a reversal in the indicator more likely. Here we have the settings of .04 in the step and .20 in the maximum.

We see a greater number of reversals and also the SAR lagging further from price.

Sensitivity also declines if we lower the maximum. If we reduce it from .20 to .04 we see that changes in trend are less likely. The maximum is more easily attained when set to lower levels. In this case, the calculation is less likely to change and we see less sensitivity. Moreover, SAR stays further from price.

What are the best settings?

Naturally, there is no correct answer to this. For those who want tighter stops to more easily protect profit or limit downside, having a higher step and higher maximum would be best.

For example, settings of .05 for the step and .40 for the maximum would produce fairly tight stops as represented by the level of the SAR dot and its proximity to price.

These settings would also be relevant for those who use parabolic SAR as a trend following indicator and prefer the indicator to have higher sensitivity and thus more frequent changes.

For those who want more accommodative stops to avoid getting stopped out prematurely and to allow “breathing room” in one’s trades, having a lower step and lower maximum would be appropriate.

In this case, settings of .01 for the step and .02 for the maximum would provide loose stops.

Those who use parabolic SAR for trend following might also prefer this setting to keep track of a broader view of the trend, rather than one that oscillates more frequently as with higher step and maximum values.

Conclusion

Parabolic SAR is regularly used to track trends. It also serves as a guide for where traders should place their stop-loss to limit the downside and/or protect the profit associated with their trades. The progressive dot configuration of the indicator functions very similarly to the adjustment of a trailing stop.

The settings of the indicator can be adjusted from its step and maximum value of .02 and .20, respectively.

Those wanting to increase the sensitivity of the indicator – which gives rise to more frequent changes in the trend (as diagnosed by the SAR) and tighter trailing stops – should increase the step and maximum value.

Those wanting to decrease the sensitivity of the indicator – less frequent changes in the trend and looser trailing stops – should decrease the step and maximum value.

The settings should be evaluated on a security by security basis and in line with one’s trading preferences. There is, of course, no correct answer as to which are best. The default settings are naturally the most frequently used.

Like all indicators, is should never be used in isolation. Developing a complete trading system involves using multiple modes of analysis, from looking at price action and/or other technical indicators and fundamental analysis.

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