Parabolic SAR

The trend is our friend right? So what about when the friendship is over?

Well unlike in Ninja life where it gets messy, in trading we can use the Parabolic SAR to guide us through.

The SAR stands for "Stop and Reverse" which gives you a clue that it's used to show where a trend may be coming to an end i.e. stopping and reversing.

A parabola is a U shaped curve which appears on your chart as a series of dots. A parabola below the price generally indicates a bullish market, while a parabola above generally indicates a bearish market.

It's pretty easy to interpret this indicator.. when the dots are above the candles it's time to sell and when they are below it's time to buy. Think of those dots as hands holding up the price in an uptrend or pushing down in a downtrend. When those hands flip, it's time to get out.

This indicator is rarely used for entry. Instead traders use it to exit or, as prices tend to stay within this U shaped curve during a strong trend, to set (manual) trailing stops. Put simply, keep moving your stop to the level of the previous dot.

Let's look at an example:

In the example above let's say you have entered a long trade on GBP/JPY 4hr at the break of the orange line. You can now use the Parabolic SAR dots as your trailing stop, by moving the SL of the current candle to the SAR dot of the previous candle (purple arrow). You can see as the trend slows down that the SAR dots move closer towards the candles, until eventually your SL is hit.

Ok, so we said it's an easy one but you knew there'd be a catch right? Of course there is! This indicator is very good in strongly trending markets however in ranging markets or periods of consolidation it can lead to many false signals. You can see this in the above example where after the trade was exited the market moved into a consolidation period and the Parabolic SAR dots chopped and changed all over the place – not a good place for trading.

So the lesson here is to establish the strength of a trend first before you get in then use this indicator to time your graceful (and hopefully profitable!) exit and go find a new friend.