Parabolic SAR is a technical analysis indicator developed by Welles J. Wilder. It was first described in Wilder’s 1978 book, New Concepts in Technical Trading Systems. SAR stands for “stop and reverse”, it trails the price action as the time passes. The indicator is positioned below the price when the prices are soaring, and above the price when the prices are falling. The author himself called this indicator the “Parabolic Time/Price System.”
The indicator was developed with the purpose of notifying the trader about possible trend changes. Being a unique indicator with high practical potential, Parabolic SAR should nevertheless be combined with other indicators for maximum accuracy.
How does the Parabolic SAR work?
The idea behind the indicator is quite simple. When the price crosses one of the Parabolic SAR dots, the indicator is expected to turn around and appear on the opposite side of the price line. Such behavior can be a signal of an upcoming trend reversal or at least a trend slowdown.
The Parabolic SAR can predict trend reversals, as illustrated by situations 1, 2, and 3
It can be seen in the picture above that when the Parabolic SAR touches the price, the trend changes its direction. This risk-following indicator can be used to estimate optimal entry/exit points, predict the trend direction and forecast future behavior of the price action.
Settings for Intraday Trading
In order to use the Parabolic SAR technical analysis indicator, do the following:
- Click on the “Indicators” button in the bottom left corner of the screen,
- Choose the Parabolic SAR from the list of possible indicators,
Setting up the indicator in the IQ Option platform
3. Click “Apply” if you want to use the indicator with standard parameters.
4. Or switch to the “Set Up & Apply” tab and configure the indicator according to your liking.
Using the Parabolic SAR with standard parameters
The trader can adjust two technical parameters in the “Set Up & Apply” tab, which are acceleration and acceleration max. By increasing the numbers, you can make the indicator more sensitive, at the same time sacrificing its precision.
The opposite effect can be achieved by lowering the values of acceleration and acceleration max: the indicator will become less sensitive but will also provide less false signals. Finding the right balance between accuracy and sensitivity is a prime task for traders interested in using Parabolic SAR in intraday trading.
Adjusting the acceleration and acceleration max parameters
How to Use Parabolic SAR Indicator
According to Welles J. Wilder himself, the indicator should only be used during strong trends, that usually do not exceed 30% of the time. The use of the Parabolic SAR on short time intervals and during the sideways movement is not advised as the indicator loses its predictive potential and can return false signals.
The indicator loses its predictive power during periods of low volatility but provides decent results when volatility is high
Professional traders often combine the use of the Parabolic SAR with other indicators. One of the possible combinations — Parabolic SAR and Simple Moving Average — and its practical applications are described below. It is advised to double-check Parabolic SAR signals with the help of other indicators.
Parabolic SAR + SMA
The combination of these two technical analysis tools is popular among experienced traders. The Parabolic SAR (acceleration = 0.04, acceleration max = 0.4) and the SMA (period = 55) are used together to confirm each other’s signals. When using both indicators at the same time the traders are waiting for the following signals to appear:
Anticipating the bullish trend
When the price is below the SMA and the Parabolic SAR demonstrates upward movement, the trend is likely to become bullish.
Anticipating the bearish trend
Predicting upward and downward trends with a combination of the Parabolic SAR and the SMA
When the price is above the SMA and the Parabolic SAR demonstrates downward movement, the trend is very likely to become bearish.
Both situations can be seen in the picture above. In the beginning of the intervals numbered 1 and 3 it can be a good idea to invest in call options, while intervals numbered 2 and 4 correspond to the bearish sentiment.