Forex- Some Strategies Around Parabolic SAR

Published: 23rd June 2011
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Parabolic SAR or parabolic Stop and Reverse is one of the most visual technical indicator. SAR trails the price as the trend goes on. The rising dots below the price action which move up when the price is moving up and hence indicating uptrend. The falling dots above the price action and moving down with the price when the price is falling and hence indicating a downtrend. When trend reverses and when the rising or falling dots hit the price action then it's the time to stop the trade and take a position in the opposite direction. Stop and Reverse.

The answer is "No", if the question is "is it so simple". SAR does not indicate the trend and hence we cannot take buy positions when the dots are below the price action or sell simply because the dots are above the price action.

Let's see how to use Parabolic SAR?

SAR (Parabolic Stop and Reverse) helps us in indicating the following:

1) To Put trailing stop-loss orders.
2) To exit the trade when the SAR indicates that itís time to stop and reverse the direction.

But well, as we mentioned above that both of the above statements are not as simple as they seem and hence before getting a better feel of the above points let's see when the Parabolic SAR indicator works and when it should be ignored.

Rule 1: Parabolic Stop and Reverse works better in trends but should be ignored when price is running in range.

So how do we ensure the application of rule 1?
Well, the rule 1 can be applied by knowing whether the market is trending or is running sideways.

Trend confirmation:

To check whether itís truly a trending market or not can be confirmed by one or a combination of the following:

1) ADX: ADX should be above 25 and rising.
2) MACD: For uptrend a bullish MACD i.e. MACD line crossing over the signal line. For downtrend the MACD crossing below the signal line.
2) Stochastic: Bullish Stochastic i.e. stochastic line crossing over the signal line for uptrend and bearish stochastic i.e. the stochastic line crossing below the signal line.

Now SAR can be used once we know that there is a clear trend (uptrend or downtrend). Let's see how to use SAR after this confirmation:

1) Putting the trailing stop-loss orders:

If the dots are emerging below the price action and we have a long position then we can move our stop-loss levels up at the level of rising dots. We can simultaneously raise our take profit targets. We should do this by keeping an eye on the other indicators mentioned above for reconfirmation that the trend is keeping up. The same is true with short positions. We continuously move our stop-loss levels to the level of dots moving down with the price. We can also move our take-profit levels further down if other indicators are showing that the trend not slowing down.

2) Exiting the trade when the Parabolic SAR indicates that itís time to stop and reverse the direction:

Letís say that we have a long (buy) position during an uptrend. The SAR dots appearing below the price actions are also moving up. This movement is initially slow but becomes faster with time and the dots come closer to the price action. There is some correction and price moves down. The moment the moving up dots hit the moving down price, SAR indicates that it may be safer to close down the position as the price may go further down. We can close our long position and open a short position. BUT WAIT. Confirm the downward trend with the above mentioned indicators and if they are not confirming a developing downtrend then please do not open a short position. So Stop and don't reverse.

The same is true with short positions during downtrend. The price is falling and the dots are over the price action and moving down. When price reverses the direction and falling dots hit it, it indicates taking profits by closing the position.

Apart from the technical analysis indicators it's always good to keep an eye on the emerging classical Chart patterns also.


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