The Parabolic Stop and Reverse (usually known as Parabolic SAR, or just Parabolic) is a trend following indicator, that was developed by J. Welles Wilder. The Parabolic SAR is based upon the theory that a strong trend will continue to increase in strength over time, and will therefore follow a parabolic arc. The Parabolic SAR is displayed as a single parabolic line underneath the price bars for a long (upwards) trend, and above the price bars for a short (downwards) trend. The Parabolic SAR is displayed on the same chart as the price bars, and is the yellow lines in the example chart (full size chart).
- Description : The Parabolic SAR (PSAR) is the underlying parabolic arc of a trend, and uses the most recent extreme (highest and lowest) price (EP), along with an acceleration factor (AF), to determine the future points on the parabolic arc.
- Calculation :
EP = Highest high for a long trend, and lowest low for a short trend, updated each time a new EP is reached
AF = Default of 0.02 (2%), increasing by 0.02 (2%) each time a new EP is reached, with a maximum of 0.20 (20%)
PSAR = PSARn+1 = PSARn + (AF * (EP - PSARn))
Exceptions : If PSARn+1 (the next PSAR) is within or beyond today's or yesterday's price range, PSARn+1 is set to the closest price. For example, in a long trend, PSARn+1 would be set to the closest low, and in a short trend, PSARn+1 would be set to the closest high.
As the Parabolic SAR is a trend following indicator, it is only designed to be used in confirmed trends, and will give very bad results in a small ranging or sideways market. Entries are signaled by the start of a new parabolic arc, and exits are signaled by the price touching the parabolic arc. As the price touching the parabolic arc, is also the reason for the start of a new parabolic arc, the exit from the current trade and the entry into a new trade occur at the same time (hence the name Parabolic Stop and Reverse). An alternative way of using the Parabolic SAR might be to indicate the direction of the current trend, and then make entries and exits based upon another indicator (such as a momentum indicator).