The Parabolic SAR can be a useful in detecting trends and shifts in trends.

The Parabolic SAR (SAR stands for Stop-and-Reversal) is an indicator that places dots on a chart whether they be above or below the candle, but sometimes they will touch a candle wick.  It is an indicator that is used frequently for determining exit points, but it is effective for determining entries as well for those looking to trade reversals.  It’s a simple indicator to trade, but finding a way to trade with it and use it in an automated strategy is a little more challenging as the way it is used.  Testing it as an entry and exit qualifier will provide some sense of its effectiveness.

Parabolic SAR Explained

Parabolic SAR is a simple to interpret indicator.  If the Parabolic SAR is below the price, the trend is bullish and if the Parabolic SAR is above the price, the trend is bearish.

The Parabolic SAR rises and falls until the trend is finished.  The Parabolic SAR when it is staying with a trend will never go against the trend, which means that the Parabolic SAR will never dip in a bullish trend and will never spike during a bearish trend.

In the above chart, it is evident that it is an effective indicator for trailing stops, exits, and establishing new trends.  Its weakness is also obvious, it performs terribly in ranging markets and environments.  If the price is choppy, this indicator is useless.

The most common setting is for the Step to be .02 and the Maximum to be .20.  The Step is actually an acceleration factor that plays into Parabolic SAR being an indicator that takes into account a flexible definition of an expiry point on a trend, much like the way an Option has an expiry date.  Each time a maximum or minimum is reached, the dots get higher or lower (closer to the price), which is why there is an overall Maximum to keep everything constrained and usable.  The above chart is for .02 Step and .2 Maximum.

Parabolic SAR with a .5 Step and a 5 Maximum would look like this.

Parabolic SAR with a .005 Step and a .01 Maximum would look like this below.

Setting the Parabolic SAR higher makes it more sensitive to price movements and reduces its ability to track trends.  Setting the Parabolic SAR lower makes it less sensitive to price movements and reduces its responsiveness to detecting trends.

Now it is time to give Parabolic SAR Indicator a test run with several strategies.

The Parabolic SAR Indicator will be tested with either the prescribed currency pairs for the particular strategies or EURUSD and USDJPY.  They will be used with 1 Hour and 4 Hour Charts, ignore the Stop Loss and Take Profit figures in the results because they are just placeholders and they do not reflect the actual results.

Strategy #1:  Parabolic SAR Indicator + ADX

This strategy combines two indicators that the creator of the Parabolic SAR, Welles Wilder, suggested should go together.

  • Currency Pair:  Any currency pair and time frame can be used.  (EURUSD and USDJPY)
  • Indicators: Parabolic SAR default settings (0.02, 0.2), ADX 50 (with +DI, -DI lines)
  • Short Entry rules: When the +DI line is below the -DI line, and Parabolic SAR gives sell signal. When the +DI line is above the -DI line, all Parabolic sell signals must be ignored.
  • Long Entry rules: When the +DI line is above the -DI line, and Parabolic SAR gives buy signal. When the +DI line is below the -DI line, all Parabolic buy signals must be ignored.
  • Exit rules: when +DI line and -DI lines have crossed again.

EURUSD – 1 Hour

USDJPY – 1 Hour

EURUSD – 4 Hour

USDJPY – 4 Hour

Strategy #2:  Moving Average and Parabolic SAR Indicator

  • Currency Pair:  Any currency pair and time frame can be used.  (EURUSD and USDJPY)
  • Indicators: Parabolic SAR default settings (0.02, 0.2), 40 period SMA, 20 period SMA
  • Short Entry rules:
    • Entry Type #1:  When the Parabolic SAR is above the candle, the 40 period SMA must cross above the 20 period SMA.
    • Entry Type #2:  When the 40 period SMA is above the 20 period SMA, the Parabolic SAR changes from being below the candle to above the candle.
  • Long Entry rules:
    • Entry Type #1:  When the Parabolic SAR is below the candle, the 20 period SMA must cross above the 40 period SMA.
    • Entry Type #2:  When the 20 period SMA is above the 40 period SMA, the Parabolic SAR changes from being above the candle to below the candle.
  • Stop Loss:  40 pips (the creator said that this was appropriate for traders of all types)
  • Exit:  When the 20 SMA crosses the 40 SMA the other way.

EURUSD – 1 Hour

USDJPY – 1 Hour

EURUSD – 4 Hour

USDJPY – 4 Hour

Strategy #3:  Bollinger Bands with Parabolic SAR Indicator

The essence of this strategy is that the Parabolic SAR is above the Upper Bollinger Band or the Parabolic SAR is below the Lower Bollinger Band and this is a sign that the market is overbought or oversold.  The exit would simply be when the Parabolic SAR crosses the Middle Band.

  • Indicator Settings:  Bollinger Bands (20,3.5) and Parabolic SAR (.2, .02).
  • Long Entry:  Parabolic SAR is less than the Lower Bollinger Band.
  • Short Entry:  Parabolic SAR is greater than the Upper Bollinger Band.

EURUSD – 1 Hour

USDJPY – 1 Hour

EURUSD – 4 Hour

USDJPY – 4 Hour

Strategy #4:  Supply and Demand with Parabolic SAR as an Exit

Supply and Demand Reversal Trading concepts with Parabolic SAR flipping sides as the Exit.

EURUSD 1 Hour

USDJPY 1 Hour

EURUSD 4 Hour

USDJPY – 4 Hour

Parabolic SAR Indicator Takeaways

The Parabolic SAR Indicator is flexible as it can be used for entries and exits exclusively.  It fares better on longer term charts because there are more pronounced trends and less noise.  Noise and choppiness are the Achilles Heel of this indicator.  However, the backtests performed provide a taste of what this dynamic and unconventional indicator can do.