The Parabolic SAR (stop and reverse) is a technical indicator that examines a security's momentum to get a better sense of when a trend is ending. With this information, traders can make better-informed decisions about when they should exit positions.
This indicator, which was designed by technical analyst J. Welles Wilder Jr., places dots above and below a security's price chart. When the security is climbing, the dots go below its price movement. Alternatively, a technical analyst will place dots above the security's price movements when that security is enjoying an uptrend.
These dots are interpreted in a rather straightforward manner. Any dots placed under the security's price graph provide a bullish signal, and the dots that appear above it confer a bearish one.
Leveraging Trend Reversals
If the Parabolic SAR shows that a security is changing from one trend to another, this information could give a trader the input they need to buy or sell.
For example, if a currency pair such as the EUR/USD has been rising in value, but this indicator reveals it has changed direction, a trader may use this knowledge to take profits.
Likewise, if that same currency pair has been following a downtrend, but the Parabolic SAR indicates the pair has started climbing, a trader may interpret this situation as a good time to buy in.
Support And Resistance
In addition to using the Parabolic SAR to pinpoint trend reversals, traders can use the indicator to determine support and resistance levels.
If a currency pair is trending upwards, the line of dots that forms underneath its price increase can also function as a support level. While this support level can serve as a point at which traders will buy up the currency pair, any movement below this support could result in breakout trading and therefore a sizeable loss.
On the other hand, if a currency pair is trending lower, the line of dots that forms above its declining price can serve as resistance. Should this pair suddenly climb in price until it hits resistance, it encounter a price wall formed by traders eager to sell. However, if the pair manages to surpass this resistance, it could enjoy breakout trading and therefore notable gains.
While the information provided in this article may make the Parabolic SAR seem simple enough, keep in mind that the signals provided by these dots are far easier to interpret when a security is experiencing upward and downward trends.
If the market for the security becomes more erratic, the Parabolic SAR can provide a trader with a lot of mixed signals that make it difficult to make a decision. Therefore, this indicator is more valuable when the market is dominated by trends, and less valuable when the market is volatile.
Traders should also keep in mind that they can combine the Parabolic SAR with other technical indicators such as moving averages, candlesticks and stochastics to find the best points to enter and exit positions.
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Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…