This is the second 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 that article, we covered the background of the “Parabolic Stop and Reverse”, or “SAR”, indicator, how it is calculated, and how it looks on a chart. 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 is not technically classified as an “oscillator”, but the indicator is often used with oscillators. The parabolic “dots” are easy to interpret. Each point represents a potential reversal in pricing behavior. The dots appear below price indicia on an uptrend and above them on a downtrend. The SAR indicator works best in trending markets, but can give false signals in ranging sideways markets.
How to Read a Parabolic SAR Chart
Your Link The Parabolic SAR with an acceleration factor of “0.02” (Max set at “0.20”) is depicted by the series of “red” dots in the above “5 Minute” chart for the “EUR/USD” currency pair. In the example above, a major down and uptrend occur in the beginning of the chart, followed by sideways “choppy” movement thereafter.
The key points of reference are the “switchover” points above and below the “candlesticks”. The Parabolic SAR attempts to signal the beginning and ending of a forceful trend. The ADX indicator is recommended as a “partner” in order to get a measure of the strength of the prevailing trend. The ADX readings for both initial trends on the chart are above “40”, representing strong trends in place. However, during the “choppy” portion of the pricing behavior, two false SAR signals in the “green” circles were produced, accompanied by weak ADX values.
As with any technical indicator, a Parabolic SAR chart will never be 100% correct. False signals can occur in ranging price behavior, but the positive signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding SAR signals must be developed over time, and complementing the SAR tool with the ADX indicator is always recommended for further confirmation of potential trend changes.
In the next article on the Parabolic SAR indicator, we will put all of this information together to illustrate a simple trading system using this Parabolic SAR.
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