The Parabolic Time/Price System, developed by Welles Wilder, is used to set trailing price stops and is usually referred to as the ‘SAR’ (stop-and-reversal). It is an indicator that is a very useful and accurate tool during a trending period. Parabolic SAR should only be employed in trending markets – when it provides excellent entry and exit points. It is plotted in a rather unorthodox fashion: a stop loss is calculated for each period using the previous periods data. The advantage is that the stop level can be calculated in advance of the market opening.
Three keep concepts are necessary for the calculation:
A periodic ‘extreme point’ which occurs when the instrument makes a new high or low, significant point, and an ‘acceleration factor’.
Extreme Point: This is the highest price recorded for the day during a long trade or the lowest price recorded for the day during a short trade.
Significant Point: The SP is the highest price reached in a long trade or the lowest price reached in a short trade. It is equal to the extreme point when a trade is closed.
Acceleration Factor: The Acceleration Factor starts at 2% for a new trade and increases by 2% on each period that a new extreme point is reached. The maximum acceleration factor is 20%. No further increases are made after this figure has been reached.
- On period 1 of a new trade (the period that the trade is entered), the Parabolic SAR is taken as the significant point from the previous trade. If the trade is Long the SP will be the extreme Low reached in the previous trade. If the trade is Short then the SP will be the extreme High reached in the previous trade.
- To calculate Parabolic SAR for the following period:
Take the difference between the extreme point and the SAR (on period 1) and multiply by the acceleration factor.
If the trade is Long, add the result to the SAR on period 1.
If the trade is Short, subtract the result from the SAR on period 1.
- There is one exception:
Parabolic SAR is never moved within the range of the current or previous period (highest High to lowest Low over the 2 periods).
If this occurs in a long trade, use the lowest Low over the 2 periods as SAR for the following period.
If short, use the highest High over the 2 periods as SAR for the following period.
- Repeat the Parabolic SAR calculation for each subsequent period, adjusting the Acceleration Factor whenever a new extreme point is recorded.
- The trade is reversed when price equals the Parabolic SAR for the period.
Parabolic SAR’ is an indicator that is very useful during a trending period. It sets trailing price stops for long or short positions. SAR stands for ‘stop and reverse’. The term ‘parabolic’ that resembles a parabola comes from the shape of the curve created on the technical chart. Parabolic SAR is called a reversal system that is used to decide stop point & to estimate when to reverse a position & trade in the opposite direction. It is an outstanding indicator commonly used day trading to provide exit point.
The first entry point on the buy side occurs when the most recent high price of an issue has been broken and it is at this time that the SAR is placed at the most recent low price. As the price of the instrument rises, the dots will rise as well, first slowly and then picking up speed and accelerating with the trend. It is understood that Wilder built-in this accelerating system to allow the trader to watch the trend develop and establish itself. The SAR starts to move a little faster as the trend develops and the dots soon catch up to the price action of the issue you are following.
The Parabolic SAR provides excellent exit points. You should close long positions when the price falls below the SAR and close short positions when the price rises above the SAR.
If long (i.e., the price is above the SAR), the SAR will move up every period, regardless of the direction the price is moving. The amount the SAR moves up depends on the amount that prices move.
Minimum acceleration factor (Min AF): The values used for initializing and stepping the acceleration factor (AF). It is also called initial/Incremental step. The default is set to .02
Maximum Acceleration factor (Max AF): – The maximum value that can be used for the acceleration factor (AF). The default is set to .2