This is the third article in our Parabolic SAR series. If you haven’t already, we suggest that you check out the first article about the Parabolic SAR Indicator. In the previous two articles, we have covered the background, the calculations involved, and how to use and read the SAR indicator. Traders use the indicator to designate optimal entry and exit points. The system gets its name from the parabolic form of “dots” that follow underlying trends. The Parabolic SAR indicator works best in trending markets, but can give false signals in ranging sideways markets.
Forex traders focus on the Parabolic SAR key points of reference, which are the “switchover” points above and below the “candlestick” formations. As with any technical indicator, a Parabolic SAR chart will never be 100% correct in the signals that it presents, but the signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding SAR signals must be developed over time. In the example below, let’s develop a simple trading system based on Parabolic SAR signals and alerts.
The following trading system is for educational purposes only. Technical analysis takes previous pricing behavior and attempts to forecast future prices, but, as we have all heard before, past results are no guarantee of future performance. With that disclaimer in mind, the “red” circles on the above chart illustrate optimal entry and exit points, and the “green” circles indicate false SAR signals accompanied by weak ADX readings.
A simple trading system would then be:
- Determine your entry point after the SAR switchover for an uptrend accompanied by a strong ADX reading;
- Execute a “Buy” order for no more than 2% to 3% of your account;
- Place a stop-loss order at 20 “pips” below your entry point;
- Determine your exit point when the SAR switches over at the end of the trend.
Steps “2” and “3” represent prudent risk and money management principles that should be employed. This simple trading system would have yielded a profitable trade of 70 “pips”, but do remember that the past is no guarantee for the future. However, consistency is your objective, and hopefully, over time, Parabolic SAR Technical Analysis will provide you with an “edge”.
That concludes our series on the Parabolic SAR Indicator. For further reading visit our Forex indicators section.
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