forex-scalping.com

Parabolic SAR: A Trailing Stop That Never Stops Flipping

Parabolic SAR, from Welles Wilder, plots dots above or below price. Dots below price suggest an uptrend, dots above suggest a downtrend. When price crosses the dots, the indicator flips sides.

Its design is a trailing stop that accelerates. It starts slowly, and each new extreme moves the dots closer to price, according to an acceleration factor. The standard settings are 0.02 for the step and 0.2 for the maximum.

In clean trends it works nicely as an exit tool, locking in profit while giving the trend room. In sideways markets it is a disaster, flipping repeatedly and producing a string of small losses.

That makes it a tool with one job. It is not a good entry signal by itself, since flips come after price has already moved. But as a way to trail a stop on an existing winning trade, it is simple and systematic.

Combining it with a trend-strength filter helps. If ADX shows a weak trend, ignore the dots.

Beware that dots show the next period's stop, so they will move even if you do nothing, which tempts traders into constant adjustment.

Practical step: on a chart with a clear trend, compare where SAR would have exited with where you would have exited by feel, and record the difference in pips.

One thing to add: Parabolic SAR works best in strong trends and falls apart in ranges, where it flips back and forth and gives you a string of small losses. I'd only use it to trail a stop once I already know the market is trending. For example, once a trade has reached 1R and the 1 hour chart is making clean higher highs and higher lows, switching to SAR dots as the trailing stop can keep you in the move while protecting gains. Before that point, a stop beyond structure is usually better. Also note that the dots speed up as the trend extends, so on long runs they can get very close to price and exit you on a normal pullback.

The default settings are fairly sensitive. Lowering the acceleration factor makes the dots sit further from price and flip less often, which suits slower trends. Just don't optimise it to death on old data. The defaults are 0.02 for the starting step and 0.2 for the maximum. Changing the step to 0.01 roughly halves how fast the dots catch up with price. In ranging markets SAR flips constantly and produces loss after loss, so many traders only use it when ADX shows a trend, or use it purely as a trailing stop on trades entered with another method.