Introduction to Parabolic SAR

SAR : A technical analysis strategy that uses a trailing stop and reverse method called “SAR,” or stop-and-reversal, to determine good exit and entry points.

Introduction: Developed by Welles Wilder, creator of RSI and DMI, the Parabolic SAR sets trailing price stops for long or short positions. Also referred to as the stop-and-reversal indicator (SAR stands for “stop and reversal”), Parabolic SAR is more popular for setting stops than for establishing direction or trend. Wilder recommended establishing the trend first, and then trading with Parabolic SAR in the direction of the trend. If the trend is up, buy when the indicator moves below the price. If the trend is down, sell when the indicator moves above the price. Calculation: The formula is quite complex and beyond the scope of this definition, but interpretation is relatively straightforward. The dotted lines below the price establish the trailing stop for a long position and the lines above establish the trailing stop for a short position. At the beginning of the move, the Parabolic SAR will provide a greater cushion between the price and the trailing stop. As the move gets underway, the distance between the price and the indicator will shrink, thus making for a tighter stop-loss as the price moves in a favorable direction.

There are two variables: the step and the maximum step. The higher the step is set, the more sensitive the indicator will be to price changes. If the step is set too high, the indicator will fluctuate above and below the price too often, making interpretation difficult. The maximum step controls the adjustment of the SAR as the price moves. The lower the maximum step is set, the further the trailing stop will be from the price. Wilder recommends setting the step at .02 and the maximum step at .20.

Example :
The chart for Suzlon Energy in Nov.2009 shows how the Parabolic SAR can catch most trends and allow the trader to profit from the buy/sell signals.
A proper interpretation of this indicator would suggest that a trader should close long positions when the price falls below the SAR (red arrow) and close short positions when the price rises above the SAR (green arrow)

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