Greetings traders and welcome back.
Thank you for joining me for another In-Depth with Chris episode.
Today's subject will be the parabolic SAR.
This is a technical analysis indicator and we'll be diving
into some of the settings that are around this indicator, as well as
the strategies that we can use to potentially find
buy opportunities and sell opportunities with the help of the parabolic SAR.
Now before we dive any deeper, let's show you how you can
apply the parabolic SAR to your charts,
that way you can follow along the entire time. The first thing
we're going to do is click the show indicators button in the top center here.
Then we're going to scroll down towards parabolic SAR.
We're going to give that a click, go back up to the top, click
the hide indicators options button,
and now we have the SAR on our screen, and we are good to go.
Without further ado, let's get going folks.
The parabolic SAR is one of the most popular technical analysis
trading indicators out there. The idea is that it helps us highlight
the direction an asset's price is moving, and give us a potentially
perfect entry location for these reversals. In the name parabolic SAR, the SAR portion
this guy here, stands for "Stop And Reverse". That is literally
what it stands for. By its nature, this is an indicator that we're going to
use to attempt to identify reversals in the market as one of the opportunities
that this indicator can present for us.
The parabolic SAR is a time and price indicator that is obviously
based in technical analysis trading because it is using historical
price data to create its drawings.
It's used to identify the direction of the asset's price and
potentially the best entry and exit points, as we discussed,
but we didn't discuss is that it was developed by our friend,
J. Welles Wilder Jr. This is the individual who came up with the relative strength
index, which we've covered in the past.
That's the RSI, and the RSI is another legendary indicator that
is used by traders all over the planet.
If you hear the name Welles Wilder, there's a good chance
that anything around that might have some merit to it.
The first time that we apply the parabolic SAR to our charts,
it may look as though we have just added a bunch of random
dots across the chart with no real rhyme or reason.
This couldn't be farther from the truth.
If we analyze the relationship that the historical path that
price is taken in relationship to the dots that are now on
our chart, we'll begin to see a story taking place. When the
dots are on the underside of price moving upwards, this usually
means that price itself is also moving upwards.
When the dots are on the top side of price and moving downwards,
this means that price is also most likely moving downwards.
What we see is that while the dots are on the top side,
they can't also be on the bottom side. They transition from
the top to the bottom, but they never are on the top and
the bottom at the same exact time.
The idea here is, as price switches, or as the dots switch from bottom to top,
we are expecting some type of reversal, or witnessing some
type of reversal occur in the market.
If it's going from bottom to top, then that means that we
are losing our bullish momentum potentially, and anticipating
some bearish momentum to follow, as long as the dots stay on the top side.
But, if we go from the top side to the bottom side, then we
are witnessing the sellers lose their strength and
we are prepared for the buyers to then take control of the
market and begin pushing price higher.
This is why in parabolic SAR, the SAR literally stands for "stop and reverse".
It is worth noting that J. Welles Wilder Jr.
said that this indicator should always be used in conjunction with something else.
That something else could be outside price action, or
outside indicator usage, or anything to help confirm what we are seeing.
The parabolic SAR itself is excellent at identifying the
predetermined trend, but after that, it is up to us to determine
the strength of that trend. The parabolic SAR indicates which
way the market may be trending, but it doesn't necessarily
show us the strength of a trend, as well as other forms of
analysis might. Here we have ourself a buy signal. With
this signal, the idea here is when the dots switch from the
top side, which is a bearish market condition, to a dots on
the bottom scenario, that is a bullish market condition.
The transition that is happening in this phase here is when
we're looking to execute a buy into the market, and the
reason is, with dots on the bottom side after coming from
a series of dots on the top side,
we are experiencing a change in hands here.
We're experiencing a change in hands where the market is
going from sellers to buyers, and we're trying to catch this
opportunity as early as possible.
As soon as these bubbles switch, somewhere around this
location with conjunction of price action, maybe it'd be
a push beyond a specific level,
maybe it'd be using RSI, or any other type of momentum indicator,
or just paying attention to volume itself,
we would look for an execution during this flip to go long,
expecting the price to rise. Now when we exit, the market
could be simply back when the dots decide to flip from the
bottom side back to the top side, so we could use this as
our exit location for a take profit goal.
The only downside about this that I should definitely
mention is, it doesn't give us a predetermined take profit goal
if we are waiting for the dots to flip.
We're kind of sitting there riding it as long as we possibly
can, and getting out when it does flip.
It does require us as traders to stay alert and to stay
focused while we are in a trade with this type of logic behind our entry.
Here we have another buy signal opportunity,
but at this time, we're using that outside advice that J. Welles
Wilder gave us, and we've applied a 200 period moving average to the chart.
The reason is, the 200 period moving average gives us an overall
trend direction on a larger scale than the parabolic SAR
itself is providing because as you can see, if we were to
just look at the parabolic SAR, you'll see periods where
the market is being told to us
is bullish, also when the market is being told to us is bearish,
and back and forth a few times over.
What this could provide for us is multiple buy opportunities,
as well as sell opportunities, which we're going to get into
in just a second. The idea is, we're only interested in
the opportunities that are with the overall momentum and the overall trend.
The reason is, the old adage, "the trend is your friend" absolutely
applies. If we are in a scenario where price is trading
continuously above this green line, which represents our
200 period moving average,
then we are only interested in the buy opportunity scenarios
as we have here, as we have here, and we have a few others
along the way, but the market was quite choppy over here,
and as we'll talk about shortly, when the market gets choppy
and isn't showing strong trending characteristics, the parabolic
SAR does suffer in those conditions.
Here we have a sell signal, which is simply going to be an
inverse of our original buy signal.
We don't have any outlying moving average applied to this
sell signal at the moment just to show you the concept here.
Once again, the idea is just going to be a reversal of
what we were doing for the buy, so when the dots go from the
bottom side to the top side during this period here, during
a trending market, we'd be looking to execute a short with
the expectation of the market to fall.
Our exit location could come at the time that the dots then switch over yet again.
As the dots go from the top side back down to the bottom
side, this would be the time for us to jump out of our position
because the dots are indicating that there might be further
bullish activity to come, and if we are in a short, that's not good for us,
so that's a good time for us to get out.
This is a simplistic version,
I'm only teaching this to give you guys the basic concept,
but I strongly encourage you put your own fine touches
on it because with a few modifications here and there,
the parabolic SAR can become a very powerful tool.
I've seen multiple traders use the parabolic SAR in conjunction
with a few other indicators like some WMA's like we talked
about in the past to pass the Gauntlet Mini.
If you're interested in passing the Gauntlet Mini, make
sure you check out the parabolic SAR in conjunction with
outside momentum indicators.
Now, let's take a quick look at the default settings of the parabolic SAR,
and this is what they should be regardless of what platform you're using,
but I personally am using the Finamark platform. On the left side,
we have something called the step over here.
Then on the right side, we have the max step.
The setting that we're really concerned with is going to be the step,
okay, on the left side.
This is going to determine how closely the parabolic SAR
follows price action. The higher the step value, the closer
to price action the parabolic SAR will follow, so the quicker
it will react, but that does come with a caveat. If the
parabolic SAR is following price too closely, we'll see the
parabolic SAR flip-flop back and forth and create entirely
too many false signals along the way because it is entirely too sensitive.
I strongly recommend if you are new to using the parabolic
SAR, that you don't monkey around with the settings too much,
aside from maybe the color option down here if you're not
a fan of the cerulean blue that we have by default, but it
is something that is pretty much good to go out of the box for all intents and purposes.
Only if you are experiencing market conditions where
you need the parabolic SAR to follow more closely to price
action would we really want to adjust the step setting here on the left.
That's really the only adjusting we'd want to do at the parabolic
SAR if we are interested.
Take a good look at this chart and try to remember it because
I'm going to show you an increase in a step setting from .02 to .08.
and I'm going to see if you can spot the difference.
This is default settings by itself,
so keep an eye on it for just a moment and get ready, because
we're about to switch it over to .08.
Now we have the increased .08 setting. Can you see the difference?
Let's go back one more time.
Here, we have the standard setting .02. Notice how price is
a little bit gapped away here from the dots down here on
the bottom, and over here on the right hand side right around
this doji that I just kind of drew through. That's the first
time during this long bullish run that we finally switch
to the top side. Once again, when we switch back over to
the .08, we can see that the price is now much closer to the
bubbles. The bubbles are following price much more closely,
and reacting with a little bit more volatility with sharper turns
along the way, less smooth of a curve, almost in the same nature
that you would expect to see when you compare a short term
moving average to a long term moving average. Remember
that spot where we switched from on this small doji candle
with the .02 setting? Well, we actually switched a couple
candles before that over here on the higher .08 setting.
Once again, .02 is going to respond slower, but that is
the default setting and that is the setting that most traders
are using, but if we feel that we need to make it respond
a little bit quicker, anticipate a little bit more volatility
and some more false signals along the way as the SAR does
flip back and forth more frequently, but we will follow price
a little bit faster and may be able to respond to trades
faster on the positive side.
If we were to sum up the overall pros for using the parabolic
SAR, it can be done with looking at it as a perfect solution for steady trends.
This means that the indicator can be great help as long as
the market is exhibiting a steady trend.
It doesn't matter if it's up or down, the idea here is the market works
wonderfully during steady climbing or steady declining trends.
We also have the fact that it can be a great visualization
for the strength of a trend.
This is because the distance between the dots widens as the trend
becomes more powerful, and when the trend is less powerful,
the dots will become closer.
A very powerful trend might have dots that look something like this,
whereas a very weak trend might look more like this
in comparison. You get the idea. We also have a great choice
for active traders, and this is just due to the fact that
the parabolic SAR is definitely a sensitive indicator, which
can identify a ton of trading opportunities.
Traders that like to trade multiple times throughout the
day will love the parabolic SAR.
It's also important to be aware of some of the cons that
are associated with the parabolic SAR.
The first one is that it shouldn't be used on its own,
we did mention this. As an indicator,
it is a beautiful indicator, but we strongly recommend using
it with outside analysis to increase its accuracy.
There are traders that do use it by its own and swear by
the success that it provides, but it is our recommendation
to have the highest levels of success, that it should be used in conjunction with other
momentum identifying indicators. Number two is going to be that it can create
false signals. It can create false signals when that step setting is a little
too high. Because it is following price too closely,
it will switch back and forth, and may indicate a bearish
trend is coming even though a bullish trend continues on
thereafter. Finally, we have it isn't effective in sideways
markets, and this kind of ties into the false signals category.
That's because in a sideways market, you'll notice that the
dots keep flipping back and forth, creating false reads
that the market may be ready to run one way or the other,
but this can be avoided as long as we identify that we're
in a trending market instead of a ranging market
In conclusion, the parabolic SAR is a beautifully powerful indicator, yet
oddly lightweight. It gives us the ability to identify trends
locations during these periods where we're seeing these dots
flip back and forth with the conjunction of outside indicators,
or outside analysis.
We don't recommend using the parabolic SAR purely by itself,
as the only logic for jumping into a position, but when coupled
with a few other layers of confirmation like a simple moving average and a 200
period, or maybe a 50, whatever it is that you prefer, or maybe a little
technical analysis. Maybe you like to look for some pin bars before you jump
in, either or, whatever you prefer, as long as you couple a
few layers of confirmation with the parabolic
SAR, you might be blown away with how powerful
it is, and it might make passing the Gauntlet Mini a thing
of beauty and a thing of ease. Until next time guys, thank
you for joining me again.
It has been a pleasure and always will be a pleasure.
I'll see you all very soon. Cheers folks!