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How to Use Parabolic SAR in Forex

One of the most common strategies in forex trading is to follow trends. However, it is often difficult to know exactly when a trend has begun and – equally importantly – when it is about to come to an end.

However, there are a number of indicators which can detect when trends may be about to reverse – and one of the most popular is the Parabolic SAR.

What does the Parabolic SAR indicator look like?

A Parabolic SAR appears as a set of dots overlaid onto a price chart. The dots follow price trends, rising when the trend is upward and falling when the trend is downward. Furthermore, when the dots are underneath the current price, then this is a bullish sign, whereas when they are above the curve then this is bearish.

One of the useful aspects of the indicator is that it flips very quickly when a trend reverses. For instance, it may be following a price trend upwards, converging towards the current price from below. Then, it will instantaneously flip above the price line, showing that the trend has reversed. A similar phenomenon happens in the other direction – the indicator tracks the downward price from above and then simply flips below the price line, again indicating a trend reversal. In both cases, the point at which it does this is referred to as the Stop And Reverse point – hence SAR.

How is the Parabolic SAR indicator calculated?

The way that the indicator is calculated is actually fairly straightforward. Each SAR point is simply the sum of the previous SAR point plus an additional factor that is calculated as follows:

Current SAR = Previous SAR + Acceleration Factor x (Extreme Point – Previous SAR)

The Acceleration Factor (AF) simply controls the speed at which the indicator converges towards the current price in a trend – higher values make it converge more quickly. The default value is 0.02, although the maximum value can be set as high as 0.20 in most charting packages.

The Extreme Point (EP) is simply the highest high in a trend that is moving upwards, or the lowest low in a downward trend. In effect, the equation guarantees that if the previous SAR is less than EP, then the indicator will move upward, whereas if it is less than EP, the indicator will move downward.

How is the Parabolic SAR indicator used?

Using the indicator is actually very simple. When a SAR point occurs and it is below the current price – in other words, the dot moved from above the price line to below the price line – then you should take a long position. Use the SAR as the stop loss, and exit once the indicator flips again. You can then reverse the strategy, taking a short position as you close your long position, again using the SAR as the stop loss and exiting the short position on the next flip.

In general, it is best to use the Parabolic SAR for mid-term trading – for example, with 1-day charts – since this has been shown to deliver the best results historically. The indicator performs less well on lower frequency charts – such as weekly charts – and high frequency charts tend to generate less profits because of the high number of trades that result.