The Parabolic SARS (Stop And Reversal System) is a trading indicator used by traders in the forex, stock, commodity, futures, indices market. This indicator was developed by J. Welles Wilder Jr, who happens to be the same person who developed the RSI; kindly read: How to Profitably use Relative Strength Index in Intraday Trading.
What Is Parabolic SARS?
The Parabolic SAR, which is the short name for the “Parabolic Stop And Reversal System” is an indicator that graphically shows series of dots above or below the candle stick depending on the type of charting formation you are using on your trading platform.
The picture below is an example of a Parabolic SARS on a forex chart.
When the dots are above the candlestick (price), it means the current price is trending downwards and when it is below the candlestick (price), it means the current price is trending upwards.
How to Effectively Use the Parabolic SARS in Forex Trading
Many traders DO NOT use this indicator effectively as such they always enter into a trade either too early or late which might end up being a losing trade.
To effectively use this indicator we need to consider the following:
The Asset Type
Though the parabolic SARS can be use on almost all financial instruments, there are some, which do not give a desired result. Some stocks or indices, which do not move in a uniform pattern, cannot give a better representation of the trend when used with parabolic SARS, look at the picture below.
The Volatility of the Market
The volatility of the market plays a very essential role in markets where geo-political news and financial event greatly influences the movement of the market. These influences on the market price causes spikes, whipsaw and irregular candlestick pattern. The parabolic SARS will not give a good trade signals when use on markets with high volatility.
The best period to use this indicator is when the financial instrument is trending. In a sideways market, the indicator will likely fail. Because it will not clearly show when a reversal will occur.
The parabolic SARS aid traders not just only identifying new trends but also showing the possible direction of that trend movement thus giving a better trade signal for entry and exit.
How to Use the Parabolic SARS
If your trading terminal is the Meta Trading 4 or 5, you can get the parabolic SARS indicators from the indicator tab else contact your broker for instructions.
The default setting for the Parabolic SARS is in the picture below and if you want to change it, I recommend you first test its performance on a demo account before using it on your live account.
The basic use of this indicator is to show you when a possible reversal is about to happen. Therefore, I recommend using the higher time frame such as the daily –to see a larger picture of the market.
The reason is because a downtrend on a 1-hour period might not be the same on the 4 hours or daily period, so to get a better picture for a day we will use the daily time frame in all our examples on this article.
When you use the parabolic SARS on a daily time frame you will clearly see the uptrends, ranges and downtrend just like the picture below.
For the sake of this article, we will use currencies and not stocks or indices etc.
To be able to filter out fake signals, you can either use Support and Resistance or use Fibonacci Retracement Levels both works well and can help define areas where price might likely fall or reverse.
Things to Avoid When Using Parabolic SARS
Do not use the parabolic SARS as a standalone indicator you should always accompany it with either a reversal price action such a Support and Resistance Zones, Candle Stick Pattern, Fibonacci Retracement Zones or other indicators such as Moving Average, RSI, etc.
Avoid News Trading:
Since the release of news and other financial or political events plays a major role in the price of currencies, stocks, bonds, ETFs etc. It is advisable not to trade during those hours as the parabolic SARS might show signals due to rapid price movements.
Do not Trade the first 3 Dots
The Parabolic SARS get its values for calculation from the price data such as opening, closing, high and lowest price from a candle or bar stick and any rapid or uneven price movement can make the dots disappear that is why I recommend the daily time frame which give a steady price representation.
CHECK OUT:What Are Shares in the Stock Market?
The parabolic SARS is not for scalpers or day traders, as it requires patience and a bit of skills to use it right.
Using the parabolic SARS can give you an edge, as you will most of the times, follow the trend and the rate of you getting stop out will slightly decrease if used effectively.
One of the advantages of using this indicator is that: it will show you a potential level to always place your stop loss. Check the picture below.
To maximize your profit, use a minimum win to loss ratio of 1:2 or 1: 3. For example if your stop loss is 60 pips away, make your profit to be 120 pips in the case of using a win to loss ratio of 1:2.
Have you been using this indicator in your trading or do you plan to use it. Please I will love to hear about your experience. Do comment below and share to create more awareness.