PSAR Indicator Expained

Definition of the PSAR Indicator:

The Parabolic Stop-and-Reversal (SAR) indicator, which is yet another indicator developed by Welles Wilder, is designed to detect trend reversals as well as create a way to trade them. The indicator is able to create exit points for both long and short positions in such a way that it allows for reactions or fluctuations at the beginning of the position, but accelerates upward (for long positions) or downward (for short positions) as the movement tops out.

PSAR

The Parabolic SAR appears on the charts in the form of dots. These dots are found below the price action when prices are rising and above the price action when prices are falling. In this regard, the indicator will keep on trailing the price until the price stops and starts to reverse. The best use of the Parabolic SAR is in trending conditions. If the currency pair is in an uptrend, then this is a pointer towards long positions. If the trend is downwards, short positions are assumed.

Indicator Settings

The indicator is listed on the MT4 among the indicators. To attach it to the MT4 chart, click on Insert -> Indicators -> Trend -> Parabolic SAR.

PSAR2

In terms of appearance, some modifications to the look of the indicator can be made. These modifications can be either to increase or reduce the line thickness of the individual moving averages or to change their colour to make them distinct from each other, especially when several moving averages are used.

Usage of the Parabolic SAR in Forex Trading

The three main uses of the Parabolic SAR in forex trading are as follows:

  • Determining the trend of the currency pairs.
  • Picking out entry and exit points for trades
  • As a trailing stop for active trades

Para_SAR

The Parabolic SAR can be used alone if it is used as a trailing stop mechanism to trail advancing price action. However, it must be combined with other indicators if it is used as a means of picking tradable signals or in trend determination.

  1. As a Trailing Stop

The Parabolic SAR tends to trail advancing prices in an uptrend, or retreating prices in a downtrend. It can therefore serve as a trailing stop. The question is: how exactly is the Parabolic SAR used as a trailing stop?

The conventional trailing stop on the trading platforms is a volatility stop. One complaint many traders have about it is that it can be too tight and you can never tell when prices have reversed completely until the trade is stopped out. In contrast, the Parabolic SAR dots take some time to catch up with the price, and even at that it still maintains a healthy distance. So when the dot now appears on the other side, it is a clear signal that the move is over and it is time to pack up. You will therefore have to move your stop loss manually to conform to the value of the dot of the Parabolic SAR while it is still chasing price.

The tightness of the Parabolic SAR lies in the step settings. A higher step setting will make the Parabolic SAR more sensitive to price movements. This will however make the trailing stop function a lot tighter, and we will also see more fake reversal signals. It is therefore a lot better to leave the step settings as they are by default.

  1. Combination of Parabolic SAR with other indicators

We have described at least three strategies where the Parabolic SAR is used with other indicators to produce tradable strategies. This is the trend-detection role of the Parabolic SAR in action. The reason why the other indicators are added, is to get the exact point of entry for the trade, as well as get trend confirmation. If you have looked at a typical chart with the Parabolic SAR indicator on it, you will discover that the buy or sell signals of the Parabolic SAR appear on the candles even when the trend is nearly flat. So you will need confirmation that the market will indeed trend so you can follow the signals with confidence.

For the trade examples, we will refer you to at least one of the Parabolic SAR strategies here.

Conclusion

Make sure you practice how to trade each setup on a demo account before using the indicator to trade real money. Also pay attention to risk management. We also ask you to refer to the Forex Strategies section to see how the Parabolic SAR has been deployed in forex strategies.

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