Technical Studies: Parabolic SAR

The Parabolic Stop and Reverse (SAR) indicator, devised by technical analysis pioneer Welles Wilder, is an upper chart indicator that sets an entry and exit point for trading a particular security based on time, price and direction (long or short).

Direction: As Wilder states in New Concepts in Technical Trading Systems, the Parabolic SAR "is a true reversal system; that is, every stop point is also a reverse point." The Time/Price System, as Wilder refers to it, is designed so that technicians close long positions and initiate short positions when the security's price dips below the SAR. Similarly, they close short positions and initiate long positions when the security's price rises above the SAR.

Time and Price: The Parabolic SAR can be a profitable system in a trending market because it factors time into its calculation. When the security's price penetrates the SAR and the direction of the trade is reversed, the initial SAR point is normally quite far from the current price. Over time, the SAR accelerates in the direction of the price, thus creating what's known as a trailing stop. In a long trade, the SAR accelerates with every new high reached. In a short trade, the SAR accelerates with every new low reached. If the price trend reverses or slows, the accelerating SAR will penetrate it fairly quickly. The strength of the price trend therefore dictates how long the technician is permitted to stay in the trade. Wilder recommends using the SAR system only in trending markets.

Customizing the Parabolic SAR: The default parameters for the Parabolic SAR are an acceleration factor of 0.02 and a maximum acceleration factor of 0.2. In a long trade, each new high for the period (minutes/hours/days/weeks/months) results in an incrementally higher acceleration factor, to a maximum of 0.2. As the acceleration factor increases, so does the speed of the SAR in the direction of the current price.

You can customize the acceleration factor between 0.018 and 0.021. And you can set the maximum acceleration factor between 0.2 and 0.22. Changing either parameter will affect the pace and location of the SAR points.

Calculating the Parabolic SAR: The formula for Wilder's Parabolic Time/Price System is explained in New Concepts in Technical Trading Systems, published in 1978 by Trend Research. ISBN: 0-89459-027-8.