Indicators can help us a lot in deciding the trade direction. In the previous post we talked about how to use momentum indicators for making trading decisions, today we will discuss another indicator which is widely used in technical analysis.
Parabolic SAR(Stop and Reverse) indicator was invented by Welles Wilder, he has also created RSI indicator. This indicator is mainly used to determine the direction of trend and to generate trading signals. It is a lagging indicator which means it follow the trend and doesn’t signals the trend change in advance. This indicator is useful for trending markets only, therefore its signals in the range bound market should be avoided.
Since all paid and free charting software provides this indicator we don’t need to do its mathematical calculation. Just for the knowledge the formula for parabolic SAR calculation is
Where SARn and SARn+1 represent the current period and the next period’s SAR values, respectively. EP (the extreme point for particular period), The α value is the acceleration factor.
This indicator generates dots in the charts to generate signals. The dots below the price indicates that up trend is there and dots above the price indicates the continuation of down trend. Buy signal is generated when the price breaks above the red dots. The sell signal is triggered when the price moves below the green dot.
The best thing about this indicator is that it provides the trailing stop loss levels. This trailing stop loss gets adjusted for each day, so you will always earn the maximum profit on your trades by using this indicator.
Note: Use this indicator with other indicators, don’t just follow this indicator alone. Don’t trade on its signals if the prices are not trending.
Abhishek is an Engineer MBA in Finance and Certified Research Analyst. He is an active trader and investor in the stock market since 2010. Follower of the philosophies of Warren Buffet and Peter Lynch in investing and trend following in trading.