J. Welles Wilder Jr’s Stop And Reverse indicator was at the root of all things when it comes to trading.
What’s in a name? SAR doesn’t stand for Search And Rescue, but it should — the market is unforgiving, and sometimes there is only one thing that will save you. Stop And Reverse is a must-know, and it’s about trend reversal. Especially if you’re trading with a lot of leverage, knowing when to get out of the trade is vital. Not noticing a trend reversal will cost you — and sometimes it costs a pretty penny:
Parabolic SAR indicator: what to eat with
SAR was developed by J. Welles Wilder Jr., a mechanical engineer and the best technical analyst at the time according to Financial World. He is also the author of the famous RSI indicator, which, some say, is sufficient to trade with forever.
However! SAR, despite its brilliance, attempts to do something that by definition sucks: trying to guess the future depending on the past. Our conclusion? Take it with a pinch of salt. SAR is best used when combined with other indicators (like all indicators in general).
What is it?
This technical indicator, like RSI, (which will be added at the bottom so you can conclude the price movement), will attempt to provide you with an educated guess of where the price is going as well as entry and exit points (these are especially useful). However, like an unfaithful husband, it lies and it’s often late. Just get another one to go with it.
SAR is calculated based on some really high-end maths. Wilder, who (literally) wrote the book on SAR, was a very influential trader and analyst (as in, really anal about maths). He was fond of parables, hence the name.
Over the years, Wilder has developed more accurate commodity trading systems and concepts than any other expert. — Financial World
How to use it?
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SAR shows up on your graphic like a set of wolf tracks in the snow around a sleigh. Sometimes they’re above the line, sometimes below — and it’s when they start going from above to below very quickly (or from below to above) — that’s when you want to start paying attention.
If dots are below the line, it’s a bullish trend. If they’re above, it’s a bearish one. Why so many animal metaphors, you ask? Well, if you think we’re lion, you can check our koalifications.
Should I rely on it?
Although SAR signals are helpful, they are notoriously unreliable. They’re kind of like a Search And Rescue Team who are good but because they love their jobs so much they can’t wait to get out there to search and rescue and don’t check the details, so they go to Lithuania instead of Latvia.
However, they’re particularly useful if you want to implement a stop-loss. Move your stop-loss where the SAR is.
What’s best to go with it?
To maximize your chances, you can combine SAR with other indicators like RSI, moving averages or ADX. For example, if SAR dots tell you to start buying (before they were below and then they’re above — beginning of a downward trend).
Using RSI you can analyze the situation: if it’s in the 70s the price is more than likely going to go down. Wilder himself was very fond of the RSI:
“OH: You are probably best known for inventing the Relative Strength Index (RSI), Average Directional Index (ADX) and Average True Range (ATR). Which of these is the most powerful tool for a trader?
WW: The ADX.
OH: Is it the indicator you are most proud of?
WW: I guess so.
OH: The Failure Swing Point is an important feature of the RSI. However, it seems to be used very little. How powerful is it?
WW: It’s powerful. I don’t know why it is not more used. It could be people don’t understand it very well.”
What to watch out for: Parabolic SAR strategy
As far as investors are concerned, SAR is normally good for markets with one steady trend, whereas when the market is choppy it’ll keep waving back and forth, sometimes leading you on in the wrong direction. Chasing SAR alone will leave you hurting!
Letting your emotions override your plan or system is the biggest cause of failure. — Wilder
What to really watch out for?
Although some techniques are better than others, and combining them is a good idea, there is no Holy Grail when it comes to trading. No-one sees the future.
It is perhaps possible to combine indicators in ways that would create a perfect strategy, but if there was one perfect way, everyone would be using it and making fortunes. Instead, in Forex alone more than 95% of people fail and lose money. Never stop learning and keep a cool head!
More animal analogies
You’ll notice that during strong trends the gap between the dots and the price widens (a strong sleigh rider will scare away the wolves). During choppy or flat markets they get very close.
It’s possible to calibrate SAR so it gets more precise if you change step values. Lowering the step values will increase SAR’s accuracy while taking away from its sensitivity. A well-calculated SAR indicator is a more helpful friend. It does drop the ball a lot though, so to avoid lags use other tools.
Combining SAR with moving averages helps it look less like this old kung fu movie dog with lagging voiceover:
Parabolic SAR trading: what to read
We recommend Wilder’s book ‘New Concepts in Technical Trading Systems’, especially if you’re a fan of RSI like us and want to find out more about trading with other lesser-known indicators like Average True Range. Check it out!
Remember that SAR may be very helpful for setting stop-loss orders. SAR is also quite laggy, and you want to mix it with other indicators like RSI, moving averages, and so on. Don’t let yourself get carried away by emotions as Wildes said, and use trading instead of letting it use you. Always keep a cool head. Trading is a lot like a casino, even when you’vу used up all the indicators on the chart. And you don’t want to get addicted and end up one of those guys who sit there for 14 hours straight and wee in a plastic cup. You don’t want to be that guy, so you’ll have to search for and rescue yourself. Stay in control!
Choosing a good exchange will take a huge weight off your shoulders. Try out SAR with Nominex! No fluff, no copypasted UX, simplicity,
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