What is Parabolic Stop and Reversal (SAR)?
This indicator was created by Welles Wilder. It was developed for trend monitoring and not to give us input/output signals but to adjust its STOP LOSS.
Indeed, when the position no longer generates any gain and starts to stagnate, some traders tend to consider it better to liquidate it.
Indeed, stubborn trading is rarely a healthy solution and in case of loss, some people wait far too long before triggering their stops: they think that prices will return to their original level and can be in denial for very long periods to try to be right against the market. It’s the best way to burn down your account. The loss, if triggered, allows you to move on to something else and release the capital for other trades. This is why the Parabolic SAR was developed.
SAR is a kind of mobile stop protection: SAR lines are getting closer and closer to prices as they evolve in our favor.
During trends, this helps to protect against a price reversal by collecting profits quickly.
SAR (n) = SAR (n-1) + acceleration factor x ((maximum value reached) – SAR (n-1))
The acceleration factor can be modified by the trader, but the creator of the indicator recommends using the value 0.02. The greater this factor, the more sensitive the SAR will be to price changes.
The maximum value reached is the highest or lowest price.
It is important to note that this indicator is useful in trends: it will give results in range.
The Protection Stop can be placed at the points of the parabolic SAR in a trend: you can place your STOP just at the last SAR point and adjust your stop as the trend changes.
Example of using the Parabolic SAR strategy in daily: we adjust our stop every day at the last SAR point, which would have allowed us to take a nice drop and quit almost at the lowest level.
Usage limitation of Parabolic SAR
This indicator is only valid for trends. It will not be very relevant to use it in a range since, in times of uncertainty, the market turns around all the time. However, the primary objective of this indicator is to come out at the best price when the trade is correctly placed in the direction of the trend and not to let a gain turn into a loss.
Then, it is important to understand that this indicator is useful for placing stops: it is useless to enter or exit positions, it only serves as an evolutionary stop loss. It will, therefore, be necessary to use this indicator to “secure” trades, but positions will be taken with the help of other indicators.
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