What is Parabolic SAR
Many trading strategies are based on divergences. The main target of the technical analysis, in this case, is to find a moment when the price action diverges to the current market trend, showing a contradiction to the main tendency. That happens when sellers go too far with the retracement depth during an uptrend and buyers support the current price with too heavy volume, despite the general downwards direction of an asset. Such a bounce gives a perfect chance to enter the market, following the main trend and place orders according to the main speculative flows. Moreover, the depth of retracement is one of the key parameters in the technical analysis to monitor in the scope of renewal of by-trend positions if the previous positions were closed with a profit, or adding more volume for profitable deals, using buy-and-hold trading strategy.
What is Parabolic SAR Indicator
Parabolic SAR use three different technical indicators to find such a moment of too deep correction in the market in order to enter the current trend. Parabolic SAR, a well-known trend indicator, is based on a calculation of the market momentum, comparing close prices in a given period. Traditionally, SAR trade is represented by dots which are placed below the current price (in an uptrend) or above it (downtrend). The key trading signal comes when Parabolic indicator jumps below the price, being placed above it earlier. That’s an example of the trend to change its direction from bearish to bullish. In the opposite, sellers take the market under control when Parabolic SAR dots jump above the price after a period of staying below it. However, this trading strategy is not intended to find reversals, so Parabolic SAR is needed only to show the general tendency in collaboration with other tools, so we are not using any such examples here.
The second technical indicator in this trading system is the Awesome Oscillator. One of the main advantages of the tool is that it has a double level of representing the current situation from the technical point of view, underlying the importance of momentum change before the price reaction. It’s placed in a window below the price chart and it’s represented in a form of a histogram, the bars of which can be placed above (uptrend) or below (downtrend) zero level. Colours of the bars are also important as Awesome Oscillator is able to show a moment when the current trend loses its momentum, pointing to a potential reversal or consolidation period. When a bar changes its colour to red from green during the period of sustainable growth and being placed above zero levels, that’s usually a strong signal to monitor the price action more closely for a possible slowdown of the latest bullish run. At the same time, during a bear market, Awesome Oscillator can show a period when the likelihood of consolidation or even sudden reversal is getting higher. It happens when the histogram bars change the colour from red to green, even if they are still below the zero marks. But again, all we need from the indicator here is just to confirm the general trend strength.
Last but not least, the 5-bars exponential moving average completes the list of the technical indicators to be used with Parabolic SAR forex trading strategy. The curve is supposed to show the perfect entry point, signalling a divergence between three different indicators. A trading signal occurs when the current candlestick closes below EMA5 for an uptrend and above EMA5 during a downside price action. Once that happens, we just go long in the first case and short in the second one. The main idea is based on the fact that if two strong technical indicators such as Parabolic SAR and Awesome Oscillator indicate a sustainable uptrend without any reversal signals on the cards, while the current price crosses EMA5, then the price action goes against the general trend and the retracement is deep enough to enter the market.
If you like this strategy, you might also be interested in this Donchian Channel Strategy
How to use Parabolic SAR?
Parabolic SAR is pointing to the uptrend continuation with its dots placed below the current price. Awesome Oscillator is showing strong bullish momentum with its bars above zero and green. But the current candlestick closes below EMA5 curve.SHORT positions:
Parabolic SAR indicator is pointing to the downtrend continuation with its dots placed above the current price. Awesome Oscillator is showing strong bearish momentum with its bars below zero and red. But the current candlestick closes above EMA5 curve.
This trading technique was developed to be used on technically correct and comparatively slow currency pairs such as USD/CHF and EUR/USD. Their volatility is rather low which is supported by a large trading volume, in comparison to more fast pairs like GBP/JPY, for instance. This Parabolic strategy can also be used with AUD/USD for example. The best timeframe to trade on is 30-minutes chart. Both indicators should have default parameters, there’s no need to change anything for the given assets. However, this combination of technical indicators can be used with other trading instruments with higher volatility, with the condition of changing the settings which could be suitable and unique for any chosen currency pair. Stop-loss and take-profit orders should be comparatively tight, given the low volatility of the assets and short-term timeframes: 14 and 20 pips respectively for both EUR/USD and USD/CHF.
The chart of the Parabolic SAR strategy in action will look like this:
Parabolic SAR Formula
SARn+1= SARn + α (EP – SARn)
- SARn is the current period and 1 - is the next period SAR value;
- EP represents the highest price in an uptrend and the lowest in a downtrend;
- The α value represents the acceleration factor.
Usually, this is set initially to a value of 0.02, but can be chosen by the trader. This factor is increased by 0.02 each time a new EP is recorded, which means that every time a new EP is observed, it will make the acceleration factor go up.