Parabolic SAR Indicator Guide: How to Use SAR for Trading

The Parabolic SAR (Stop and Reverse) is a unique technical indicator that provides both trend direction and potential reversal points. Created by J. Welles Wilder Jr., the same trader who developed RSI and ATR, Parabolic SAR appears as a series of dots above or below price candles. This guide will teach you how to effectively use this powerful trend-following tool.

What is Parabolic SAR?

Parabolic SAR stands for "Stop and Reverse." The indicator plots dots that trail behind price, creating a parabolic curve. When price is rising, the dots appear below the candles. When price is falling, the dots appear above. The "stop and reverse" name comes from its original design as a system that is always in the market, either long or short.

How Parabolic SAR is Calculated

The calculation involves an Acceleration Factor (AF) that increases as the trend extends:

• SAR = Prior SAR + AF x (EP - Prior SAR)
• EP (Extreme Point) = Highest high in an uptrend or lowest low in a downtrend
• AF starts at 0.02 and increases by 0.02 each time a new EP is made
• AF is capped at 0.20 maximum

The acceleration factor causes the dots to move closer to price over time, making it more likely for price to touch them and trigger a reversal signal.

Reading Parabolic SAR Signals

Bullish Signal

When dots flip from above price to below price:

• The trend has potentially reversed from bearish to bullish
• Consider entering long positions
• Use the SAR dots as your trailing stop

Bearish Signal

When dots flip from below price to above price:

• The trend has potentially reversed from bullish to bearish
• Consider entering short positions or exiting longs
• Use the SAR dots as your trailing stop

Trading Strategies with Parabolic SAR

1. Basic Trend Following

The simplest approach uses SAR flips as entry and exit signals:

• Buy when dots flip below price
• Sell when dots flip above price
• Always be in a position (long or short)

2. Trend Confirmation Strategy

Combine SAR with trend indicators for higher probability trades:

• Use a moving average to determine overall trend
• Only take SAR buy signals when price is above the MA
• Only take SAR sell signals when price is below the MA
• This filters out many whipsaws during consolidation

3. SAR as Trailing Stop Only

Instead of using SAR for entries, use it purely for exit management:

• Enter based on your preferred method (breakout, pullback, etc.)
• Once in profit, use SAR dots as your trailing stop
• Exit when price crosses the SAR level
• This lets you ride trends while protecting profits

4. Multiple Timeframe Strategy

Use SAR on multiple timeframes for better signals:

• Check higher timeframe SAR for trend direction (e.g., daily)
• Only trade in that direction on lower timeframe (e.g., hourly)
• Enter on lower timeframe SAR flip that matches higher timeframe direction
• Manage the trade using lower timeframe SAR

Adjusting Parabolic SAR Settings

The default settings are 0.02 step (AF) and 0.20 maximum. You can adjust these:

Higher Step Value (0.03-0.05)

• Dots move closer to price faster
• More sensitive to price changes
• More signals but more whipsaws
• Better for short-term trading

Lower Step Value (0.01)

• Dots trail further behind price
• Less sensitive, slower to react
• Fewer signals but fewer whipsaws
• Better for longer-term trend following

Maximum AF Setting

• Higher max (0.25-0.30): Dots catch up to price faster in extended trends
• Lower max (0.10-0.15): Dots stay further back, allowing more room for pullbacks

Strengths of Parabolic SAR

• Clear signals: The visual dots make it easy to see trend direction at a glance
• Built-in stop loss: SAR provides automatic trailing stop levels
• Catches trends: Excellent for riding strong directional moves
• Time-based urgency: The acceleration factor builds pressure, preventing you from staying too long in weakening trends

Limitations of Parabolic SAR

• Whipsaws in ranging markets: SAR generates many false signals when price moves sideways
• Late entries: By the time dots flip, some of the move may already be over
• No consolidation filter: The indicator does not distinguish between trending and ranging markets
• Fixed acceleration: The same settings may not work for all market conditions

Combining SAR with Other Indicators

Parabolic SAR works best when combined with other tools:

• ADX (Average Directional Index): Only take SAR signals when ADX is above 25, indicating a trending market
• Moving Averages: Use MAs to filter trade direction, only taking SAR signals in the MA trend direction
• Volume: Confirm SAR breakouts with above-average volume
• Support/Resistance: Look for SAR flips at key price levels for higher probability trades

Common Mistakes to Avoid

• Using SAR in choppy markets: If price is ranging, SAR will generate constant losing signals. Use it only in trending conditions.
• Ignoring the overall trend: A SAR buy signal against a strong downtrend is likely to fail.
• Setting stops exactly at SAR: Consider adding a small buffer to avoid getting stopped out by normal price noise.
• Not adjusting for timeframe: Settings that work on daily charts may need adjustment for intraday use.

Summary

The Parabolic SAR is an excellent tool for trend identification and trade management. Its visual simplicity and built-in trailing stop mechanism make it popular among traders. However, like all indicators, it works best in trending markets and should be combined with other analysis methods to filter out false signals. By understanding SAR's strengths and limitations, you can incorporate it effectively into your trading strategy.

Want to explore more trend-following indicators? Check out our guide on the Ichimoku Cloud or learn about Average True Range (ATR).