The Parabolic Stop and Reverse (SAR) indicator combines price and time components in an attempt to generate potential buy and sell signals. The Parabolic SAR advertises itself as an effective tool to determine where to place stop loss orders.
The chart below of the 100 ounce Gold futures contract is a good illustration showing possible buy and sell signals generated by the Parabolic Stop and Reverse (SAR) technical indicator:
Parabolic SAR Potential Buy Signal
A trader might buy when the price closes above the upper Parabolic SAR. When the Parabolic SAR changes from being above price to below price, then the trader might “stop” and buy to cover their existing shortsell and “reverse” direction and buy to go long.
Parabolic SAR Potential Sell Signal
A sell signal is potentially generated when the price closes below the lower Parabolic SAR. At the time that the Parabolic SAR changes from being below price to being above price, the trader might “stop” and sell to exit their existing long trade and “reverse” direction and sell to go short.
The Parabolic SAR advertises itself as a good tool in determing where to place stop loss orders. How a trader might place stop losses using the Parabolic SAR is discussed on the next page.
Parabolic SAR Stop Loss Placement
The Parabolic SAR gives suggestions as to where a trader might place stop loss orders to protect profits or minimize losses. The chart below of Gold illustrates stop loss placement using the Parabolic SAR indicator:
The Parabolic SAR might be useful to a trader because:
- It acts as a trailing stop. Rather than putting in one stop loss below where a trader entered a long position or above where the trader entered a short position, using the Parabolic SAR as a trader’s guide, the stop loss is gradually raised for a long position and lowered in a short position, effectively locking in any profits.
- It acts as a time stop. Time stops are used by traders because they enter in buy or sell orders expecting a certain move to occur. If the expected move never occurs and the reason the trader initiated the trade is no longer relavent, then the trader would probably exit their trade. Similarly, the Parabolic SAR incorporates time into its calculation making sure a stock, future, or currency trade is working for the trader, if the trade is not moving in the desired direction, the Parabolic SAR will suggest an exit point.
The Parabolic SAR indicator created by Welles Wilder and chronicled in his classic New Concepts in Technical Trading Systems attempts to give easy to interpret buy and sell signals as well as attempts to create an easy to follow methodology for entering stop loss orders.
How to Start Trading
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