The Parabolic SAR is a trend-following technical indicator that identifies the direction of a security’s momentum and serves as a trailing stop. It forms strings of dots shaped like a parabola. It’s called “SAR” (Stop and Reverse) because when reached by the price, it stops the current string and reverses to the other direction to form a new string of dots.
When the SAR is touched by the price, it begins to form at the other side of price, signifying a shift in the trend and a trade signal to the opposite side.
Beginning at a certain distance, it slowly forms to the direction of the trade after every candle when a new extreme point towards the trend direction is reached. It also accelerates with every formation until it reaches the maximum acceleration set in the parameters. Normally, the SAR’s parameters are set to the step increment of 0.02 and the maximum level of 0.20. This allows the SAR to leave enough space for the price to take its normal course.
When the dots are below the price, it means the following:
The trend is going up.
There is a Long trade signal.
The price momentum is in an upward direction and will remain that way unless the price hits the SAR.
The dots will move in an upward direction only.
However, when the dots are above the price, it means the exact opposite.
The trend is going down.
There is a Sell trade signal.
The price momentum is in a downward direction and will remain that way unless the price hits the SAR.
The dots will move in a downward direction only.
The SAR serves as one of the visual confirmations of the trend, and thus, trade signals. Of course, it’s a good idea to buy when the dots are below the price because the trend is up, and it’s a good idea to sell when the dots are above the price because the trend is down.