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Using Parabolic SAR (10)

Phillip Konchar

Using Parabolic SAR

Many traders use SAR in a variety of different ways, it can be used as a trend confirmation tool, a trading signal and also as a risk management tool.

Limitations

  • SAR was designed for use in uptrends and downtrends for long time frames, but we find that SAR struggles when it comes to sideways trends and can generate multiple false signals.
  • In our experience, it also struggles and gives multiple false signals in shorter timeframes. It was designed for investors recalculating it at the end of every trading day so this is fair enough.
  • SAR is weak when a trend pauses, its parabolic nature means it can take a trader out of a healthy trend.

Confirmation Tool

SAR’s output is helpful when confirming a trend – the output is clear and can’t be misinterpreted – dashes below mean it is indicating an uptrend, above and its a downtrend. 

Remember, we are looking for potential long setups in an uptrend and short setups in a downtrend – so it is a good tool to use when confirming the trends direction.

Trade signal

Some traders use Parabolic SAR as a trading system – its original purpose. When the trend switches the trader switches their position.

In this example, you can see the limitations of SAR as a trading system – the sideways trend over on the right of the chart gets ignored, the trader would get whipsawed when all that is happening is a consolidation.

Risk management tool

The most popular way to use SAR is as a risk management tool. SAR calculates the value for the next period and can never be moved back against a trend, this means it’s very useful for setting and adjusting objective stop losses. As the trend develops the trader moves their stop loss in line with the level given by SAR – this is an objective way to lock in a profit when you catch a trend.

Key Learning Points
  • SAR is used as a trend confirmation tool, a trading signal and a risk management tool.
  • The most popular use for SAR is as a risk management tool.
  • When using SAR the longer the time frame the better the results in our opinion.
  • SAR struggles in sideways trends and in short term timeframes.
  • SAR is also weak when a trend pauses, its parabolic nature means it can take a trader out of a healthy trend.

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