Welles Wilder's Parabolic SAR (SAR) is a trading system based on trailing stop loss and is often used as an indicator. SAR uses trailing stop levels to follow the price as it rises or falls. The stop level increases in speed based on the 'acceleration factor'. When plotted on a chart, this stop level resembles a parabola, hence the name of the indicator. The parabolic function takes three parameters. The first two control the acceleration when moving up and down. The last parameter determines the maximum acceleration.
Parabolic SAR assumes that you are trading a trend, so it expects the price to change over time. If you are long, the Parabolic SAR will move the stop level up each period, regardless of whether the price has moved. If you are short, the Parabolic SAR will move the stop level down.
How does this indicator work?
The Parabolic SAR trading system uses the Parabolic SAR level as the "stop loss and reversal" point to calculate the stop loss for each upcoming period. When the stop loss point is hit, you close the current trade and initiate a new trade in the opposite direction. This system allows you to invest in the market at all times.
Indicators are usually displayed as a series of dots above or below the price bars. The dots represent stop levels. When the stops are above the bars, you should be short; when the stops are below the bars, you should be long.
The Parabolic SAR can cause whipsaws in sideways or choppy markets.
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