How to use Parabolic SAR in your trading practice?

Intermediate
March 29, 2023
Read time:
6m

The Parabolic SAR (Stop and Reverse) Indicator is used to determine trend direction, monitor asset price fluctuations, and identify proper entry and exit points.

How does it work?

In crypto trading, the Parabolic SAR analyzes the price movements of a cryptocurrency and identifies potential trend reversals.

The formula for the Parabolic SAR indicator is quite complex, as rising and falling SAR is calculated differently.

Rising Parabolic SAR = Prior SAR + Prior AF (Prior EP – Prior SAR)

Falling Parabolic SAR = Prior SAR – Prior AF (Prior SAR – Prior EP)

Extreme Point (EP) is the trend's highest or lowest point.

While Acceleration Factor (AF) is set to a value that starts at 0.02 and increases by 0.02 each time the EP reaches a new high (or low). However, if the limit of 0.2 is reached, the value is maintained until the trend reverses.

How to interpret the Parabolic SAR?

Parabolic SAR is represented by a sequence of dots placed below or above the asset's price. The display of these dots creates a parabola, with every dot being one SAR value.

When the dots are below the asset’s price, it indicates a bullish (upward) trend. However, when the dots exceed the price, it implies a bearish trend.


When the Parabolic SAR dots move from below to above the price, it can be considered a sell signal, indicating that it may be time to exit a long position. Conversely, when the dots move from above to below the price, it can be considered a buy signal, indicating that it may be time to enter a long position.


Furthermore, traders may also use the Parabolic SAR dots to set a trailing stop-loss order. When the prices are increasing along with a rising value of the Parabolic SAR, the indicator's exact value can be used as a stop-loss level to exit the long order.

Advantages

The Parabolic SAR works well when identifying trends and determining the right stop-losses to protect your assets. With the help of the Parabolic SAR, investors can easily spot trend reversals, which signal when it may be best to exit their trading position.

Moreover, the Parabolic SAR works well with other indicators, such as MACD [link] and moving averages, to provide more accurate signals.

Disadvantages

On the other hand, when the price movement goes sideways, the Parabolic SAR may send false or late signals and lead to losses if traders rely on it too heavily. It is recommended to combine this technique with other methods of technical analysis to obtain optimal results.

Furthermore, Parabolic SAR is not suitable for all markets and may not work well in highly volatile ones, where it may generate too many false signals.


Summary

The Parabolic SAR indicator helps investors determine trend direction and monitor the price movements of assets, which is helpful for setting the right trailing stop orders. It's important to note that, like all technical indicators, the Parabolic SAR should be used with other indicators and analysis methods to make informed trading decisions.

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