The Parabolic SAR A Built-in Trailing Stop System

In the quest for the ideal trailing stop, traders often combine various indicators and methods. However, there is one indicator that was specifically designed to serve as a self-contained system for both trend identification and trade management: the Parabolic Stop and Reverse (SAR). Developed by the legendary technical analyst J. Welles Wilder Jr., the same mind behind the Relative Strength Index (RSI) and the Average True Range (ATR), the Parabolic SAR offers a unique and dynamic way to trail a stop-loss, allowing you to stay in a trend until the evidence of a reversal is clear.

The Parabolic SAR appears on a chart as a series of dots, either above or below the price bars. When the dots are below the price, it indicates an uptrend, and the dots themselves represent the trailing stop level for a long position. When the dots are above the price, it signals a downtrend, and the dots act as the trailing stop for a short position. The “parabolic” nature of the indicator refers to the fact that the distance between the dots and the price narrows as the trend accelerates, creating a parabolic curve.

The Mechanics of the Parabolic SAR

The calculation of the Parabolic SAR is more complex than a simple moving average, as it incorporates an “acceleration factor” that causes the stop to move closer to the price as the trend extends. The formula involves the prior SAR value, the extreme point of the current trend (the highest high in an uptrend or the lowest low in a downtrend), and the acceleration factor.

When a new trend begins, the acceleration factor starts at a default value (typically 0.02) and increases by that same amount each time a new extreme point is reached, up to a maximum value (usually 0.20). This built-in acceleration means that the stop-loss will move slowly at the beginning of a trend, giving the trade room to establish itself, and then accelerate as the trend matures, locking in profits more aggressively.

How to Use the Parabolic SAR as a Trailing Stop

The beauty of the Parabolic SAR is its simplicity in application. The indicator itself provides the exit signal. When you are in a long position, your exit signal is when the price closes below the SAR dot. This indicates that the upward momentum has faltered, and it is time to take profits. Conversely, if you are in a short position, you would exit when the price closes above the SAR dot.

| SAR Position | Trend Direction | Action | Trailing Stop Level | | :