The Parabolic Time/Price System, developed by Welles Wilder, is used to set trailing price stops and is usually referred to as the ‘SAR’ (stop-and-reversal). It is an indicator that is a very useful and accurate tool during a trending period. Parabolic SAR should only be employed in trending markets – when it provides excellent entry and exit points. It is plotted in a rather unorthodox fashion: a stop loss is calculated for each period using the previous periods data. The advantage is that the stop level can be calculated in advance of the market opening.
Significant Point: The SP is the highest price reached in a long trade or the lowest price reached in a short trade. It is equal to the extreme point when a trade is closed.Acceleration Factor: The Acceleration Factor starts at 2% for a new trade and increases by 2% on each period that a new extreme point is reached. The maximum acceleration factor is 20%. No further increases are made after this figure has been reached.
On period 1 of a new trade (the period that the trade is entered), the Parabolic SAR is taken as the significant point from the previous trade. If the trade is Long the SP will be the extreme Low reached in the previous trade. If the trade is Short then the SP will be the extreme High reached in the previous trade.
- To calculate Parabolic SAR for the following period:
Take the difference between the extreme point and the SAR (on period 1) and multiply by the acceleration factor.
If the trade is Long, add the result to the SAR on period 1.
If the trade is Short, subtract the result from the SAR on period 1.
- There is one exception:
Parabolic SAR is never moved within the range of the current or previous period (highest High to lowest Low over the 2 periods).
If this occurs in a long trade, use the lowest Low over the 2 periods as SAR for the following period.
If short, use the highest High over the 2 periods as SAR for the following period.
- Repeat the Parabolic SAR calculation for each subsequent period, adjusting the Acceleration Factor whenever a new extreme point is recorded.
- The trade is reversed when price equals the Parabolic SAR for the period.
Maximum Acceleration factor (Max AF): – The maximum value that can be used for the acceleration factor (AF). The default is set to .2