Parabolic Stop and Reversal (SAR)

Summary

Parabolic SAR was developed by Welles Wilder and it is used to determine the ending and consequently the reversal of a trend. For that reason it is widely used by traders to identify suitable entry or exit points of their trading strategy. In a chart it is illustrated by the use of dots that are positioned above or under the candlesticks.

Calculation

SAR (n) = SAR (n-1) + α x [EP (n-1) - SAR (n-1)]

where,

SAR (n-1) is the previous value of the indicator

EP is the extreme point price. EP(n-1) refers to the highest / lowest price for the previous period depending on the positioning long / short, respectively

α is the acceleration factor. It is common to set the initial value of α at 0.02. Subsequently whenever a new EP is observed the factor increases by 0.02. In order to prevent high values of α, it is usual to set a maximum value of 0.20.

Signals

Dots formed below the price (candles) indicate a bullish signal. While dots formed above the price, provide evidence for a downward trend.