In the foreign exchange market or any other market, it is vital to keep up with the trends by spotting them quickly. It is also important to know when a trend ends because it becomes easier to leave the trade before making any losses. Traders use different technical indicators to help them in monitoring market activities and identifying the end of trends. One such technical indicator is Parabolic SAR.
Parabolic SAR (PSAR) forex trading Strategy that goes by the name Parabolic Stop and Reverse is a popular indicator that follows market currency trends. It is a creation of J. Welled Wilder, and it exhibits dots set below the price bars if there is an uptrend and above if, there is a downtrend. The technical analysis indicator determines where dots will appear using the recent EP (Extreme Price with an AF (Acceleration Factor).
If used in consolidated markets, PSAR moves back and forth, leading to false signals generation. However, to confirm existing trend strengths, traders can use other stronger indicators such as average directional index momentum. The three main functions of PSAR are to highlight the direction of the current price or trend, provide currency entry signals, and provide expected exit signals.
How to Calculate Parabolic SAR
The following are the PSAR calculations for uptrend and downtrend.
Uptrend: – Prior PSAR + Prior AF (Prior EP – Prior PSAR) = PSAR
Downtrend: – Prior PSAR – Prior AF (Prior PSAR – Prior EP) = PSAR
EP is the extreme price reached for an uptrend and lowest for a downtrend. Updates take place every time after reaching a new EP. The acceleration factor (AF) has a default of 0.02, which increases by 0.02 each time after reaching a new EP with a 0.02 maximum. The strategy gets the name “stop and reverse” because the dots are always present.
PSAR calculation creates a dot either above or below the price action, highlighting the direction of the current price. If the price falls below the rising price action, dots move to the top of the price bar. If the price goes below the price action, dots flip below the line.
How to use PSAR Indicator
The primary use of the PSAR indicator is to buy when you see an uptrend, exhibited by dots moving below the price bar, and sell when there is a downtrend, shown by dots moving above the bars. Using the dot movement to trade leads to consistency in trade signals, knowing that a position will always be present.
Moreover, this is good in the price-making back and forth big swings because you can expect each trade to produce a profit. However, if the price makes small moves in each direction, you can expect the constant trade signals to make several losses.
It would be best to determine whether a trend is up or down by analyzing the day’s price action or by using another indicator such as trendlines, average directional index momentum, candlestick patterns, or moving average to establish the direction of the trend.
Pros and Cons of Parabolic SAR
- PSAR is one the easiest trading indicator to use even for first-time forex traders
- When a trend is strong, the indicator highlights it, which helps the trader hold onto his position and stay on the trending path.
- When there is a move against the trend, the indicator gives an exit signaling a reverse.
- PSAR provides traders with the generation of some of the most powerful trading signals on the currency market
- During sideways foreign exchange market conditions, the indicator does not provide the most consistent trade signals, which is also its main drawback.
- The indicator flip-flops above and below the price constantly without a clear trend.
- A trader relying solely on PSAR for trade signals could make losses in a row.
Therefore, it is important to identify and learn the trend first by using another helpful indicator to read the price action before taking any action.
Wrapping it up
Parabolic PSAR is a helpful technical analysis indicator that works best when the market has a strong trend. Compared to many other indicators, PSAR provides forex traders with better and fast exit signals, which prevents making too many losses.
Even though one of the drawbacks of the analysis indicator is that it could lead to occasional false signals, the benefits are worth making this tool essential for forex traders irrespective of their skill levels.