Stock Price trends and Parabolic Stop and Reverse (SAR)

Stock Price trends direction and SAR

Welles Wilder's Parabolic Stop and Reverse (SAR) trading system is a trailing stop-based trading system that is also used as an indicator. The SAR employs a trailing stop level that moves with the price as it rises or falls. The speed of the stop level is increased based on an "Acceleration Factor." This stops level resembles a parabolic curve when plotted on a chart, hence the indicator's name. Three parameters are accepted by the parabolic function. The first two control the acceleration during up and down moves. The final parameter controls the maximum acceleration. The Parabolic SAR assumes you are trading a trend and thus anticipates price movement over time. If you are long, the parabolic SAR will raise your stop every period, regardless of whether the price has moved. If you are short, the parabolic SAR moves downward. The SAR assumes you are always in the market and computes the Stop and Reverse point when you close a long position and open a short position or vice versa.

trends direction and SAR

How it works: The Parabolic SAR trading system employs the parabolic level as a "stop and reverse" point, calculating the stop for each subsequent period. When the stop is reached, the current trade is closed and a new trade in the opposite direction is initiated. This system ensures that you are always invested in the market.

The indicator is typically depicted as a series of dots above or below the price bars. The dots represent the various stop levels. When the stops are above the bars, you should be short; when the stops are below the bars, you should take a long position.

During sideways or trendless markets, the parabolic SAR may cause whipsaws. The Parabolic SAR may cause whipsaws during sideways or trendless markets. The parabolic SAR excels in trends that move quickly and accelerate as they progress. Stops are also calculated to accelerate, so you must have the appropriate "Acceleration Factor" for the market you are trading in. The acceleration parameters for moving up and down may differ.

Parabolic SAR Calculation

The Parabolic SAR (PSAR) indicator uses the most recent extreme price (EP) along with an acceleration factor (AF) to determine where the indicator dots will appear.
The Parabolic SAR is calculated as follows:
Uptrend: PSAR = Prior PSAR + Prior AF (Prior EP - Prior PSAR)
Downtrend: PSAR = Prior PSAR - Prior AF (Prior PSAR - Prior EP)

  • EP = Highest high for an uptrend and lowest low for a downtrend, updated each time a new EP is reached.
  • AF = Default of 0.02, increasing by 0.02 each time a new EP is reached, with a maximum of 0.20.
  • Where:
  • EP = Highest high for an uptrend and lowest low for a downtrend, updated each time a new EP is reached.
  • AF = Default of 0.02, increasing by 0.02 each time a new EP is reached, with a maximum of 0.20.

This calculation generates a dot (which can be connected with a line if desired) below or above the rising or falling price action. The dots help to highlight the current price movement. The dots, on the other hand, are always present, which is why the indicator is known as a "stop and reverse." When the price falls below the rising dots, the dots flip over to the top of the price bars. When the price rises via falling dots, the dots flip below the price. Fortunately, charting software performs all of these calculations for us, but knowing how to crunch the numbers for yourself is still useful.
Fortunately, charting the software performs all of these calculations for us but knowing how to crunch the numbers for yourself is still useful.

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