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Tuesday, May 20, 2008

Parabolic SAR (Stop and Reverse)

Parabolic SAR or Parabolic Stop and Reverse or simply Parabolic is a time/price stock market indicator, which is very a useful trading tool in a trendy market. This indicator is widely employed for placing stop-loss orders and to generate buy and sell signals. Parabolic SAR only works when market/stock is on a trend, not in choppy and stagnant markets.

Parabolic SAR is represented as dots in the trading chart; for upward trends, dots are placed below the price and for downward trends, dots are placed above. Future SAR values of stocks are calculated with respect to the current, recent top and recent low trading prices. The exact formula is very complex. The simplified one is below.
SAR = (EP – SAR1) x AF + SAR1
Where EP is the highest high or lowest low of the trend and AF is the acceleration factor. The original value of AF is 0.02 and is increased by 0.02 every time a new high or new low price is created for a trading day. The maximum AF value is 0.2.

The exit from a current position is made at the end of a parabolic SAR (the point where SAR touches the price). The entry to a new position is made from the same price (at the start of a new parabolic SAR). Trailing stop-losses are made according to the distance between price and parabolic SAR. Tighter stop-losses are made when this distance decreases and wider stop-losses when distance increase. The shrinking of distance occurs when the price is on the verge of a reversal.

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