The parabolic SAR is a technical indicator also known as the “stop and reversal system”, The parabolic SAR was developed by the famous technician Welles Wilder.
Parabolic SAR indicator is a trend indicator, used by many traders to determine the direction of an momentum and the point in time when this momentum has a higher-than-normal probability of switching directions. Parabolic tells traders about price stop-and-reverse points as well as trend direction.
Its concept of usage is easy to understand from the first look. Parabolic SAR appears as a series of dots placed either above or below price on a chart, where each dot represents certain time period.
One of the most important aspects to keep in mind is that the positioning of the “dots” is used by traders to generate transaction signals depending on where the dot is placed relative to the asset’s price. A dot placed below the price signals, traders to expect the momentum to remain in the upward direction. A dot placed above alerts traders that the bears are in control and that the momentum is likely to remain downward.
The formula of Parabolic SAR includes an “acceleration factor”, which allows to react to market changes fast as the trend starts to accelerate. At the beginning, new Parabolic SAR dots are placed close together and then accelerate as the trend advances.
Parabolic SAR has two variables: a step and max step. Settings recommended by W. Wilder are: a step of 0.02 and the max step of 0.2.
The step sets sensitivity of Parabolic SAR indicator. If the Step is too high, Parabolic SAR becomes more sensitive and will flip back and forth more often, with lower step Parabolic SAR will become smoother(see also Oscillator Indicators). Maximum step sets a cushion between price and Parabolic SAR. The higher the max step the closer the trailing stop will be to the price.