Introduction to the Parabolic SAR

Key Takeaways

The Parabolic Stop and Reverse (SAR) is a trading indicator which helps to identify trends, entry and exit signals for financial assets.

Popular among both traditional and crypto traders, the Parabolic SAR offers insights into where to buy or sell an asset in both bull and bear markets.

Parabolic SAR works on the principle of trailing signals which follow price up and down, hence why it is sometimes also referred to as the ‘stop and reverse’ system.

The indicator acts as a guide for setting stop-loss levels as part of their strategy, taking previous price action into account while doing so.

While well suited to strongly trending markets — such as those often seen in crypto — Parabolic SAR is less effective during periods of sideways price action, and is prone to offering inefficient trading signals under such conditions.

What Is the Parabolic SAR?

The Parabolic SAR offers crypto traders a composite trading tool for navigating both bull and bear markets or reversal patterns within those trends.

Its name comes from its appearance on a given chart — a series of dots above or below price which rise or fall with it according to customizable mathematical rules. Depending on the settings used, the dots can rise and fall more steeply than price itself, giving them a ‘parabolic’ quality.

The dots are calculated according to a so-called Acceleration Factor (AF), while their growth is controlled by the Maximum Acceleration (MA) parameter. Both are freely customizable in TabTrader, and Parabolic SAR’s trading signals will change as a result.

As a trailing indicator, Parabolic SAR alerts traders as to suitable entry and exit points when an asset is changing trend. Thanks to the position of the dots themselves, traders can also gauge where to place stop-loss or take-profit orders should volatility hit or the trend unexpectedly reverse. 

This is particularly relevant to Bitcoin and altcoins, which can experience rapid trend changes and moves which had not been anticipated in advance.

The indicator has been in use for decades, however, being created by John Welles Wilder Jr., the father of one of the most popular tools for day traders: the Relative Strength Index (RSI). The TabTrader Academy has a full guide to RSI and its implementation in crypto which is available here.

How Do You Calculate the Parabolic SAR?

Calculating the Parabolic SAR manually is not usually required, but is not complex compared to some other popular technical indicators such as the Average Directional Index (ADX).

First, the AF is set, and by default this is 0.02. This increases incrementally each time the price makes a higher high or lower low in its uptrend or downtrend, respectively. The MA is normally 0.2.

These aspects of the indicator can be edited to suit an individual trading strategy. Increasing the AF will lead to more trading signals as the dots will ‘hug’ price more closely, while a lower AF value will cause the dots to rise more slowly versus price, leaving more room for leeway and providing fewer signals.

Formula of the Parabolic SAR Indicator 

SAR dots can now be calculated as follows:

Uptrend (rising SAR):

RPSAR=Prior PSAR+[Prior AF(Prior EP-Prior PSAR)] 

Downtrend (falling SAR):

FPSAR=Prior PSAR−[Prior AF(Prior PSAR-Prior EP)] 

Where: 

RPSAR = rising Parabolic SAR

FPSAR = falling Parabolic SAR

EP = Extreme Point (highest high or lowest low in the current up or downtrend)

How the Parabolic SAR Works 

In everyday use, the Parabolic SAR uses the AF and MA parameters to generate a series of dots which trails price.

These appear below price in an uptrend and above it in a downtrend.

The AF controls how relatively close new dots are positioned relative to the price itself, with the gap narrowing over time, as seen in the diagram below.

When Parabolic SAR parameters signal a trend change is underway, the dots flip to the other side of price. This is known as a crossover, and is ostensibly the signal for a trader to go enter or exit as required. 

The phenomenon of the dots closing in on price forms a useful additional tool for traders. As a trend continues, the dots constrict more and more, and if used as a guide for Stop-Loss orders, they minimize the chance of closing out a trade too late should a trend weaken. 

At any given point, Parabolic SAR-based Stop-Loss strategies can provide a useful cushion against falling victim to volatility.

Rising SAR

A series of dots below price reflecting an uptrend is called a rising SAR. 

In the 1-day chart below, BTC/USD reverses from a local low around $40,700. Two candles later, Parabolic SAR begins to print dots below price, signaling a long entry.

The dots rise with price, exhibiting the indicator’s typical ‘parabolic’ trajectory, while moving nearer and nearer to the daily candles themselves.

At $67,000, the BTC/USD uptrend cools and a consolidatory period enters. Parabolic SAR prints a dot above price, suggesting a suitable exit point for the long trade. Before the first of these new dots, price retraces from a local high, almost hitting the dot below the daily candle — an example of how Parabolic SAR can act as a useful Stop-Loss guide.

In the subsequent consolidation phase, price likewise almost, but not quite, violates the overhead Parabolic SAR dot during the October 31 candle.

Using rising SAR signals, the long trade thus provides an entry at $43,300 and suggests an exit at $62,200, capturing the majority of the price advance.

Falling SAR

The inverse operation to the rising SAR is the falling SAR, used during a downtrend.

Here, exactly the same signals are used, but in reverse — an entry on the first printed dot above price and an exit when the next crossover occurs. Stop-Loss levels are moved in step with the dots for each candle, just like in an uptrend.

The chart below shows a typical falling SAR setup on an XRP/USD hourly chart. Here, falling SAR signals likewise capture the majority of downside opportunity, with the dots providing accurate Stop-Loss information.

Pros and Cons of the Parabolic SAR

Parabolic SAR signals are popular among beginner crypto traders because they are immediately visible and intelligible at a glance.

The position of the dots either above or below price gives information about the asset’s trend, while crossovers show how long a given trend has been in place (per the indicator’s own settings).

Observers can also zoom out to analyze Parabolic SAR data — a chain of short-lived trends with multiple crossovers, for instance, belies a sideways market which is not offering actionable trading signals.

As a standalone tool, however, Parabolic SAR can be said to be insufficient as the basis of an entire crypto trading strategy.

Rangebound price action is a key example of its limitations — entering and exiting positions based on SAR crossovers when each uptrend and downtrend only lasts for a small number of candles would likely result in poor performance.

Parabolic SAR is also a lagging indicator, meaning that traders can miss out on a significant portion of upward or downward volatility by waiting for crossovers and confirmations.

The picture becomes more complex when Stop-Loss orders are placed — positioning these incorrectly could spark premature position closures, or worse still, liquidations.

To mitigate the chance of falling victim to false trading signals, TabTrader recommends using Parabolic SAR in conjunction with other technical indicators in order to confirm a suitable entry or exit at a given price.

Other Indicators That Complement the Parabolic SAR

Parabolic SAR signals can be much more effective when given context by other trading indicators.

Using a combination of indicators helps to mitigate any inefficiencies produced by a specific one in particular, improving the odds of a successful trade.

Contextualizing Parabolic SAR trend data, for instance, is easy to do using moving averages. If price is consistently above a key long-term trendline, for instance the 200-day moving average, Parabolic SAR uptrend signals can be considered more reliable. The same is true in reverse for downtrends.

When assessing trend strength, one of Wilder’s other creations, the Relative Strength Index (RSI), can be leveraged. RSI offers perspective on the strength of price at a given level based on customizable retrospective data. This allows traders to essentially gauge how overbought or oversold the asset is, informing an entry or exit decision. Relying purely on Parabolic SAR data — uptrend or downtrend — would be considerably less safe.

Traders can also leverage signals on trend strength using the Average Directional Index (ADX), itself a complementary tool for use in conjunction with RSI.

Moving averages, RSI and ADX are all among TabTrader’s top recommended instruments for day trading.

Conclusion

The Parabolic SAR indicator is a useful addition to a successful crypto trading strategy.

Regardless of level of proficiency, a trader can leverage its signals to inform their entries and exits, as well as glean trend data from a given chart at a glance.

Parabolic SAR features customizable parameters in TabTrader which allow for tailored use — the frequency of signals and information on where to place Stop-Loss orders can all be controlled by the user.

The indicator is especially suited to markets prone to strong trends, while for sideways or nonvolatile assets its signals can be mixed and at times misleading. This does mean, however, that the indicator is an ideal match for crypto markets.

TabTrader recommends using Parabolic SAR in conjunction with other popular trading tools such as the Average Directional Index (ADX) and Relative Strength Index (RSI) to confirm the validity of any given signal.

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FAQ

What does Parabolic SAR tell you?In essence, Parabolic SAR shows which way an asset is moving — it may not be a firm uptrend or downtrend, but the indicator offers basic trend information at a glance.

Is Parabolic SAR profitable?

Bitcoin and crypto trading using Parabolic SAR signals can capture a significant portion of an uptrend or downtrend. The position of the dots produced by the indicator gives an insight into the progress of a given trend, while “crossovers” illustrate trend changes.

What is the Parabolic SAR strategy in crypto?

Traders seek Parabolic SAR crossovers as cues to enter a trade — watching for the dots flipping from one side of price to another. Similarly, positioning Stop-Loss orders which follow the dots is done in order to minimize risk of loss or liquidation.

Which Parabolic SAR is best?

Parabolic SAR parameters are customizable, and TabTrader allows users to employ different settings to suit their needs. The standard settings for the Acceleration Factor (AF) and Maximum Acceleration (MA) offer a solid foundation for Stop-Loss levels, as can be seen in the charts above.