The Parabolic SAR is a technical indicator that is used to determine the direction of a currency/share's momentum. It can also measure the point in time in which the momentum has a higher-than-normal probability of changing directions. The Parabolic SAR is also known as the "Stop and Reversal System".
The Parabolic SAR was developed by the famous technician Welles Wilder, creator of the Relative Strength Index (I think I forgot to mentioned that in RSI post). It involves the placing of a series of dots either above or below the price in the chart. The AUDUSD daily chart belows shows how the Parabolic SAR is plotted on the chart.
The position of the "dots" generated by the PSAR can be use as BUY/SELL signals. A dot that is placed below the price is giving a bullish signal, which will generate a BUY signal and traders will expect the momentum to remain in the upward direction. The reverse is true for a bearish signal.
The first PSAR dot on the bullish trend will be plotted when the price of the most recent high price has been breached, it is then at this time that the PSAR dot is plotted at the price of the most recent low. As the price increase, the PSAR dots will also rise slowly, picking up speed and increase with the trend. As the trend develops, the PSAR dots will soon catch up with the price action. The PSAR works extremely well in trending market, and it will lead to false signal when the market is consolidating or a choppy market.
Another exciting feature of the PSAR is that it can help to set the position of the stop-loss for the trade. It can help traders in locking in profits of the trade in a trending condition. PSAR is a wonderful indicator for use in a trending market. It tells the trader exactly when to enter and exit the market, thus eliminating human emotion in trading. The only disadvantage is when the trade is experiencing whipsaw (consolidation) whereby false signals might be given.
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