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How to Use the Parabolic SAR Indicator in Forex Trading

How to Use the Parabolic SAR Indicator in Forex Trading

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The Parabolic SAR, or Parabolic Stop and Reverse, is a popular indicator used by traders to forecast the future short-term momentum of a financial asset. Developed by ‘Welles Wilder Jr’ in 1978, this momentum indicator helps identify potential trend reversals when the price is in a strong uptrend or downtrend. In this article, you’ll learn everything about Parabolic SAR Indicator and how it can help you trade better! 

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Here are a few ways that Forex traders can benefit from using the Parabolic SAR indicator: 

1. Identifying the direction of a trend: The Parabolic SAR indicator can be used to determine whether a currency pair's price will continue to move in one direction or reverse. 

2. Setting stop-loss orders: Parabolic SAR indicators can be used to set stop-loss orders strategically. When traders expect the price to reverse, they can set stop-loss orders at those points. 

3. Identifying potential entry and exit points: Traders can identify potential entry and exit points by using the Parabolic SAR indicator. Identifying potential reversals allows traders to enter or exit markets at strategic points.

What is the Parabolic SAR Indicator? 

The parabolic SAR – or parabolic stop and reverse – is one of the most popular trend-following indicators used for predicting potential reversals and continuations in the price of a security. It is commonly used by traders to identify entry and exit points in the market, as well as to set stop-loss orders. 

The Parabolic SAR Indicator is plotted on a chart as a series of dots that are either above or below the price of the security. When the dots are above the price, it indicates a downtrend, and the dots below the price indicate an uptrend. As the price of the security moves, the dots will also move, with the distance between the dots and the price increasing as the trend becomes stronger. 

How to Use the Parabolic SAR Indicator in Forex Trading

Overall, the Parabolic SAR indicator can be a useful tool for Forex traders who are looking to identify trends, set stop-loss orders, and identify potential entry and exit points in the market. It is important to note, however, that the indicator should be used in conjunction with other technical indicators and fundamental analysis in order to maximize its effectiveness. 

The Parabolic SAR indicator was developed by Welles Wilder, Jr., and is described in his 1978 book "New Concepts in Technical Trading Systems". The indicator is designed to help traders identify the direction of a trend and determine the points at which the price is likely to reverse. It is typically used in conjunction with other technical indicators to help confirm trade signals. 

How does Parabolic SAR Indicator Work?   

Parabolic SARs usually appear as dots near price bars on an asset’s chart. Generally, when these dots are above the price, it signifies a downward trend and is a sell signal. Likewise, the downward movement of the dots indicates an upward trend and signals a buy. 

  • A Parabolic SAR trading system calculates the ‘stop and reverse’ point for each upcoming period using the parabolic level. As soon as the stop is reached, the current trade is closed and a new trade is initiated in the opposite direction. As a result, traders are always invested in the market. 
  • Usually, the Parabolic SAR Indicator appears as a series of dots above or below the price bars. Stop levels are indicated by the dots. It is best to short when the stops are above the bars and to go long when the stops are below the bars. 
  • When the market is sideways or trendless, the Parabolic SAR may cause whipsaws. 
  • Parabolic SARs excel in trends that move quickly and accelerate with time. Because stops also accelerate, you must choose the right “Acceleration Factor” for the market you’re trading. It is possible to have different acceleration parameters for the up and down directions. 

Whenever a security’s price rises, the dots also rise. As the trend accelerates, the pace accelerates as well. A Parabolic SAR can be used to capture profits by entering trades during trending markets. However, in flat or ranging markets, the indicator is less reliable. 

How to Read the Parabolic SAR Indicator (PSAR)?  

Taking a look at Parabolic SAR Indicator is straightforward and easy to understand. A bull market is indicated by parabolas (dots) below the price of the candlesticks, so traders should seek opportunities to purchase; a bear market is indicated by above-price candlesticks, so traders should seek short-sale opportunities.  

How to Use the Parabolic SAR Indicator in Forex Trading

Trend reversals can be confirmed when three consecutive parabolas form on the other side. A trend reversal would, for example, be confirmed by the appearance of three consecutive parabolas above price movement during an uptrend. 


How to Calculate the Parabolic SAR Indicator?  

The Parabolic SAR indicator relies on the principle that prices move in a parabolic pattern over time based on the concept of parabolic time/price movement. In order to calculate the Parabolic SAR, the current price of the security, its previous prices, and its trend length are taken into account. 

There is a difference in how a parabolic SAR is calculated based on whether it is used in an uptrend or a downtrend. If the price of an asset is increasing, the trend is considered up. If the price is decreasing, the trend is considered down.

For Uptrend PSAR, 

Uptrend: PSAR = Prior PSAR + Prior AF (Prior EP - Prior PSAR) 

For Downtrend PSAR, 

Downtrend: PSAR = Prior PSAR - Prior AF (Prior PSAR - Prior EP) 

Where: 

  • EP refers to the extreme point of a trend (when a price reaches its highest point during an uptrend or its lowest point during a downtrend). 
  • AF is an acceleration factor that is initially set to 0.02 (it increases by 0.02 each time the EP is recorded, up to a maximum of 0.20). Depending on the trading style or instrument being traded, traders can choose the acceleration factor. 

Using the above calculation, a dot is plotted against asset price action, either above or below. It is possible to determine the current direction of the price by looking at the dots.


How to Trade using the Parabolic SAR Indicator? 

The first step in trading the Parabolic SAR Indicator is to understand a little more about what the different signals are and what they signify.  

  • According to the Parabolic SAR, a series of dots – also known as a parabolic line – will be displayed above and below the price movements of an asset’s market price chart based on its price movements.  
  • There will either be green dots or red dots. Usually, green dots indicate a price lower than the security, and red dots indicate a price higher than it. Traders use the color of the dots to identify the trend direction quickly. Green dots indicate an upward trend when they are below the price. In the case of red dots above the price, a downtrend is evident. 
  • When trading with the parabolic SAR, you would buy a market when the dots move below the current asset price and are green in color. In the opposite scenario, you would sell a market when the dots are red and move above the current asset price. 
  • Traders look for a green dot to indicate a reversal when there are several red dots – indicating a bearish market. At this point, many traders close their short positions and open long positions in the same market if they have one. 
  • An opposite result occurs if a series of green dots is followed by a red dot. According to the series of green dots, the market is currently bullish. In the event of a market reversal, the first red dot indicates that long positions should be closed and short positions should be opened. 

You should therefore conduct your own fundamental and technical analysis of each market that you wish to trade before opening a position since the parabolic SAR indicator’s signals are not always 100% accurate.


Role of Parabolic SAR Indicator (PSAR) in Forex Trading  

Forex traders use the Parabolic SAR (Stop and Reverse) indicator to identify potential price reversals in currency pairs. Trading stop-loss orders and identifying potential entry and exit points are common uses of it. 

Here are some advantages of using the Parabolic SAR indicator in Forex trading: 

  1. Easy to use: Forex traders who are new to technical analysis can easily use the Parabolic SAR indicator. The trend can be seen on a chart as a series of dots that are either above or below a security’s price, making it easy to determine its direction. 
  1. Can help identify potential reversals: Parabolic SAR indicators can be useful for identifying forex market reversals. Traders can enter or exit trades at strategic points in the market by identifying points at which the price is likely to reverse. 
  1. Can be used to set stop-loss orders: When placed strategically, the Parabolic SAR indicator can be used to set stop-loss orders effectively. By identifying points at which the price is likely to reverse, traders can set stop-loss orders to minimize their potential losses. 
  1. Can be used to confirm trade signals: The Parabolic SAR indicator can also be utilized to confirm the trade signals generated by other technical indicators or fundamental analysis. This can help forex traders make more informed trading decisions and increase the accuracy of their trades. 
  1. Can be used in any time frame: The Parabolic SAR indicator is suitable for use in any time frame and forex trading sessions, from intraday charts to monthly charts. This makes it a versatile tool that can be utilized in a variety of trading strategies. 

Nevertheless, it is important to note that the Parabolic SAR Indicator should not be taken as a standalone indicator and cannot be relied upon entirely to forecast future price movements.


Best Parabolic SAR Indicator Combinations for Forex Trading

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Parabolic SAR Indicator is commonly used in conjunction with other indicators to provide trade signals or to confirm trend changes. Here are some combinations that you can use with the Parabolic SAR indicator: 

Parabolic SAR + Moving Average 

Forex Traders can use the Parabolic SAR indicator in combination with a moving average to confirm the direction of the trend. If the SAR dots are below the price and the moving average is sloping upwards, it is a bullish trend. If the SAR dots are above the price and the moving average is sloping downwards, it is a bearish trend. 

Parabolic SAR + RSI Indicator 

A combination of Parabolic SAR and the Relative Strength Index (RSI) can also be used by Forex traders to identify potential trend reversals. If the RSI is overbought (above 70) and the SAR dots are above the price, it may be a bearish reversal. If the RSI is oversold (below 30) and the SAR dots are below the price, it may be a bullish reversal. 

Parabolic SAR + MACD Indicator 

By combining the Parabolic SAR indicator with the Moving Average Convergence Divergence (MACD), traders can confirm trend direction and potential reversals. If the MACD is positive and the SAR dots are below the price, it is a bullish trend. If the MACD is negative and the SAR dots are above the price, it is a bearish trend. 

Parabolic SAR + ADX Indicator 

A good oscillator to qualify trend direction and momentum is the ADX (average directional index). A reading above the ADX’s centerline of 50 indicates a significant trend worth trading. A reading below 50 indicates a trend is losing steam and the market may be moving sideways. ADX shows trend direction using two lines: +DI (green line) and –DI (red line). If the green line is above the red line, it means there is an uptrend; if the red line is above the green line, it means there is a downtrend. In trending markets, Parabolic SAR delivers high-probability trading signals when coupled with ADX. 

There is no perfect indicator for predicting market movements, and it is always best to combine indicators. Other factors such as economic data and news events should also be considered when using these indicators in the context of the overall market trend.


Step-by-Step Guide to Using Parabolic SAR in Forex Trading 

Here are some steps that newbie traders can follow to trade Forex using the Parabolic SAR indicator: 

  1. Choose a currency pair: First, select a currency pair to trade. It is important to choose a currency pair that is currently trending in a clear direction, as the Parabolic SAR indicator is most effective in trending markets. 
  1. Set up the chart: Next, set up a chart for the currency pair using a charting platform or software. Make sure to add the Parabolic SAR indicator to the chart, along with any other technical indicators or tools that you plan to use. 
  1. Identify the direction of the trend: Use the Parabolic SAR indicator to identify the direction of the trend. If the dots are green and below the price, it indicates an uptrend. If the dots are red and above the price, it indicates a downtrend. 
  1. Confirm the trend with other indicators: It is important to confirm the trend using other technical indicators or fundamental analysis before entering a trade. For example, you might use moving averages or a trendline to confirm the trend. 
  1. Set a stop-loss order: To minimize your potential losses, it is important to set a stop-loss order at a strategic point in the market. You can use the Parabolic SAR indicator to help determine where to set the stop-loss order by looking for points where the price is likely to reverse. 
  1. Enter a trade: Once you have confirmed the trend and set a stop-loss order, you can enter a trade in the direction of the trend. If you are trading an uptrend, you would enter a long position, and if you are trading a downtrend, you would enter a short position. 
  1. Monitor your trade: After you have entered a trade, it is important to monitor the market closely and adjust your stop-loss order as needed. You should also be prepared to exit the trade if the trend starts to weaken or if other technical indicators or fundamental factors suggest that it is no longer a good time to be in the market. 

By following these steps, you can use the Parabolic SAR indicator to help identify potential entry and exit points in the Forex market and manage your trades effectively.


Pros and Cons of the Parabolic SAR Indicator (PSAR) 

Like any other forex technical analysis tool, the Parabolic SAR Indicator has its own set of limitations. Here are some pros and cons of the Parabolic SAR indicator: 

Pros: 

  1. The PSAR indicator is easy to interpret, as it simply plots dots on the chart that indicate whether you should be long or short. 
  1. The PSAR indicator can be used to identify both long-term and short-term trends. 
  1. The PSAR indicator is useful for placing stop-loss orders, as it can help you determine the most appropriate level for a stop. 
  1. The PSAR indicator is suitable for use within any time frame, as it adjusts to market conditions. 

Cons: 

  1. The PSAR indicator works best in trending markets, but it can give false signals in sideways or choppy markets. 
  1. The PSAR indicator is based on the assumption that the trend will continue, but this is not always the case. 
  1. The PSAR indicator does not take into account other factors that can affect the price of an asset, such as fundamental analysis or market news. 
  1. The PSAR indicator does not work well in periods of high volatility, as the SAR can move too quickly and give false signals. 
  1. The PSAR indicator does not work well for assets with low liquidity or low trading volume, as the SAR may not accurately reflect the true market conditions. 

Overall, the Parabolic SAR indicator can be a useful tool for identifying trends and making trading decisions, but it should not be relied upon solely. A combination of technical and fundamental analysis tools can give a more holistic perspective on the market.


Parabolic SAR Indicator (PSAR) – FAQ 

What is the Parabolic SAR indicator? 

The Parabolic SAR (Stop and Reverse) indicator is a technical analysis tool used to figure out when to enter and exit the market. The indicator plots dots on the chart that indicate whether you should be long or short. If the dot is above the price, it is a sell signal. If the dot is below the price, it is a buy signal.

How do you use the Parabolic SAR indicator in forex trading? 

For forex trading, you should choose a currency pair and time frame, add the Parabolic SAR indicator to your chart, set the parameters, and look for buy and sell signals. Using other indicators, you can then confirm the signals and place your orders. It is important to use this indicator alongside other technical and fundamental analysis tools, and to implement a solid risk management strategy. 

Which indicator is best with parabolic SAR? 

The Parabolic SAR can be used in conjunction with two moving averages for the best results. As the Parabolic SAR signaled a trend reversal, moving averages are used to confirm the trend reversal actually occurred. Generally, a trade signal is generated if a trend reversal is identified by the Parabolic SAR and the moving averages cross over to indicate the same change. 

Is using parabolic SAR profitable? 

Yes, the Parabolic SAR indicator is a good tool for making profits when you enter a trade during a trend in a steady market. However, to increase the chances of profitability, it is important to use the Parabolic SAR indicator in conjunction with other technical and fundamental analysis tools and to implement a solid risk management strategy. 

How do you use parabolic SAR for stop loss? 

You can set your stop-loss at or just beyond the parabolic SAR, depending on how much risk you’re willing to take. A parabolic SAR will ensure you exit the trade when the trend starts to falter. However, if you set your stop-loss order beyond the parabolic SAR, your risk of a larger loss will be higher, but you can still stay in the trade in case of fake-outs. 

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