Recently, we’ve considered a group of technical indicators – oscillators – that can be applied successfully to trade in a flat and to determine the end of correction. However, during the trend movements, oscillators show a lot of false signals; therefore, it is important to have trend indicators in your toolkit too.
Before reading the article and writing your questions in the comments section, I recommend to watch this video. It’s not long but covers the biggest part of questions on the topic.
A striking example of such indicators is called Parabolic SAR which does not need to download and installed in the MT4 trading terminal, as it is already integrated into the trading platform and ready to use. Parabolic SAR was developed by stock trader Welles Wilder and is intended for the determination of reversal points on the chart. In this article, we’ll talk about the essence of Parabolic SAR, its pros and cons, application in the trade together with other indicators, and the strategies and advisors, based on the use of this indicator.
Features of Parabolic SAR indicator application
The main purpose of the Parabolic SAR indicator consists of trend direction determination. If Parabolic points are over the price, then we have a downtrend. When the points are below the price, then it is an upward trend.
Thus, if we observe a steady formation of a point below the price over a certain period, the occurrence of a new point over the price will indicate a possible trend reversal from ascending to descending one and vice versa. In this regard, we can note the following features of applying Parabolic SAR indicator in the trade:
- A large distance between the indicator points suggests a high power of the current trend. Entering the market in this period can be pretty risky since you can get into a pullback;
- The closer Parabolic SAR points to the price is the greater the likelihood of the price reversal is;
- Parabolic points can be used as a guideline for setting stop losses, as well as for manual trailing stops. Once a new point, which is usually higher in the uptrend or lower in the downtrend, appears on the chart, you should move the stop loss level to the level of this point. As a result, when a price reversal happens, you won’t lose anything and will be able even to take your profit;
- It is recommended to use Parabolic SAR indicator on larger timeframes from H1, as due to the strong market noise on small time frames there can be many false signals;
- If you do use this indicator on small timeframes, you should not open a trade after the emergence of the first point in the opposite direction; you should wait for the signal confirmation in the form of 3-4 consecutive points.
Pros and cons of Parabolic SAR indicator
The main advantage of using Parabolic SAR is the ease in determining the trend direction and the possibility to use the tracking stop-loss (analog of a trailing stop). Therefore, Parabolic SAR can be used as an additional filter in your trading system. Nevertheless, it is not recommended to use a pure form of Parabolic SAR, because it shows many false signals in flat, which is a serious disadvantage of this indicator.
To reduce the effect of this drawback you should use Parabolic SAR in combination with the other technical indicators. They should show not the trend direction (as in this case they will simply repeat the signals of Parabolic), but the trend strength, which will help filter out the false signals formed during the price lateral movement. An example of such an indicator may be the ADX trading tool which shows the trend strength.
Trade based on Parabolic SAR together with ADX power index
At first you should set Parabolic SAR and ADX that is already integrated into MT4 terminal on your chart; thus, the ADX power indicator will open in a new window below the chart. It is a curve stretching along the line 25. If the ADX curve is below 25 mark, then the market is flat and the signals of the Parabolic SAR indicator should be ignored.
Once the ADX curve crosses the level of 25 upwards, it will mean that the price ceased the lateral movement and you can consider the signals of Parabolic SAR. When the ADX curve is above the line 30, it proves a great strength of the current trend, so it’s time to look for signals to enter.
Parabolic SAR indicator settings
Depending on your trading style you can change Parabolic SAR settings. There are two types of settings:
- Step – determines the sensitivity of Parabolic to the price change. By default, the step is 0.02. The smaller the step is the more accurate the signal will be, though they will lag a little bit. The larger the step is the more sensitive the indicator to price changes will be, which will result in an earlier determination of the trend direction, but may also increase the number of false signals;
- Maximum – this parameter adjusts the step influence to avoid distortion of the results at a pronounced trend. By default, the maximum makes 0.2, while the change of it does not has a significant impact on the overall situation.
If you change the step of Parabolic SAR it is also recommended to change the maximum proportionally (e.g., 0.02 and 0.2, 0.05 and 0.5, 0.08 and 0.8, etc.). To detect the best suiting indicator settings you need to compare your trading results with different settings of Parabolic SAR. Depending on the traded currency pair and timeframe used, different indicator settings can affect the trade profitability in different ways.
Modified Parabolic SAR indicators
Despite the fact Parabolic SAR indicator is already integrated into MT4 terminal, it has several flaws including lack of a sound signal at trend reversal, as well as a great number of false signals during the flat. Therefore, many traders develop their mechanical trading system based on Parabolic that we are going to examine in detail now.
Parabolic SAR Color – Alert
This type of indicator has a sound alert that will notify you on-trend direction change. Now you do not need to sit in front of your display anticipating the trend reversal; Parabolic SAR Color – Alert will warn you with the audio signal. Also, you can change the color of points indicating the trend direction independently. The indicator has the following settings:
- Alert Enable – this parameter is responsible for enabling the signal (by default, the audio signal is disabled; you should switch it to “true” to enable it);
You should note that the settings of Step and Maximum parameters in Parabolic SAR Color – Alert differ from the standard settings. To enable default settings you should change parameter values to 0.02 and 0.2, respectively.
Adaptive Parabolic SAR
If you look at the work of Parabolic in its pure form you’ll see many false signals. To reduce their frequency it was decided to make the value of Step parameter not constant, but variable under different market conditions. In this case, the author of this indicator bound Step parameter to values of MasterSlave volatility indicator, which makes it less sensitive during a quiet market and reduces the number of false signals.
On the screenshot, you can see that adaptive Parabolic SAR, marked with red points, shows less false signals compared to the standard indicator, marked with blue points.
Parabolic SAR Advisor
To simplify the trade with Parabolic you can use Parabolic SAR which is based on the basic principles of the well-known indicator. Once the Parabolic point arrangement changes, the advisor opens either long or short trades. If you have not reached the set take profit, but there has been a trend reversal, then the trade will be closed compulsorily and a new trend in the direction of the current trend will be opened.
To determine the optimal take profit level the advisor uses values of ATR volatility indicator. Stop-loss is set according to the classic principle – at the level of a point below (or over) the trade opening price. Trailing stop moves similarly – stop loss is moved to take profit once a new Parabolic point appears on the chart.
Parabolic SAR advisor has the following settings:
- ParabolicStep – indicator step;
- ParabolicMax – Parabolic maximum;
- ATRPeriod – period of ATR volatility indicator;
- Lots – fixed lot for all trades;
- Mul – this parameter is used for setting the multiplier of ATR, which is applied for calculating take profit levels;
- OpenOrderSound – here you can select an audio file of new position opening signal;
- MagicNumber – unique number of advisor that is used to distinguish the trades from each other.
The advisor code is open, so anyone can introduce changes to its work and adapt it for own trading system. Before enabling the advisor on a real account it is recommended to optimize its parameters and to test it at a demo account.
Simple strategy “Parabolic SAR + Stochastic”
As has been already mentioned, it is not recommended to use Parabolic SAR alone, as it increases the number of false alarms. You can use the indicators, like moving averages and Stochastic Oscillator as filters. Trade with this strategy can be carried out for any currency pairs on the timeframe of H1 and higher. At first, we need to install the following indicators on the chart:
- Parabolic SAR (step – 0.01 maximum – 0.2);
- Moving average EMA 100;
- Stochastic Oscillator (7,10,4) with levels of 37 and 63.
Let’s review a long trade example:
- Stochastic curve is above 63 level;
- Parabolic point is below the price;
- The previous candle closed above EMA 100.
If we observe all three conditions we can open a long trade. The procedure for short trades is similar, only the stochastic curve should be below the level of 37, Parabolic point moves above the price, and the previous candle closes under EMA 100.
Stop-loss is set at the level of signal candle Parabolic point. When a new point is formed the stop loss should be moved to a new level. It is not recommended to use take profit in this strategy. Trade will be closed manually, once a point on the opposite side appears or with the help of a manual trailing stop.
In this article, we’ve examined both standard and modified indicators of Parabolic and a simple advisor and profitable strategy – Parabolic SAR. Depending on your trading system you can take some useful information from this article, e.g. the principle of stop-loss arrangement or application of the manual trailing stop. Also, this indicator can be used to determine the trend direction and, together with other flat indicators, it can form a reliable trading system with accurate and profitable entries.