The Parabolic SAR
One of the best known signals that one can use is the Parabolic SAR. This is also known as the Parabolic Stop and Reserve. It is a combination of a price and time based technical analysis signal.
The Parabolic SAR was developed by Welles Wilder in 1978. The Parabolic SAR is used to trail prices with the trend that it is following. Given that it is trailing, the indicator will be below prices when there are falling and it will be above prices when there are rising. We have an example of the Parabolic SAR in the chart of the New Zealand dollar to the right.
Generally, when the prices are above the Parabolic SAR indicator then the trader will enter a long position and buy the currency. On the flip side, if prices are below the indicator then the trader will sell or go short the currency.
However, the real significance for traders from the Parabolic SAR is allowing the trader to place stop losses. Essentially the trader will use the indicator to place his / her automatic stop levels. Once the price has broken past the Parabolic SAR, this is an indicator that it has broken a trend and is possibly in line for a reversal.
What automated signal software will do is try to generate a signal based on whether the Parabolic SAR is indicating that the trend is reversing its current levels. If the software detects that the price is breaking away from an uptrend then it will issue a sell signal. The converse is of course true for a price that goes above the parabolic SAR.
Of course, using Parabolic SAR signals can be effective but you need to make sure that you are using some precautionary methods before entering the trades. These include some of the following.
- When entering the trade, your buy and sell should be the averages of the lowest and highest prices for the previous 4 candles.
- Do not trade more than at least 4% of your account size on any signal position
- If you are trading Forex, set adequate stop loss limits that are on the level of your parabolic SAR indicators
- When you decide to enter the trade with a Parabolic SAR indicator, you should make that decision based on where the current price is in relation to the indicator