This kind of indicator was introduced by Welles Wilder with the purpose of validating and rejecting trend direction. This was also designed to identify trend end, correction, as well as smooth phases indicative of exit points. It can be best referred to as ‘stop and reverse’.
It is important to understand the placement of parabolic SAR and its acceleration factor which increases just when trend does. Though this is heavily used by traders, it tends to release false and vague signals.
When confirming a trend, it is an uptrend if parabolic SAR is placed underneath the price graph. However, it is a downtrend when it is placed above the price graph.
To identify possible exit points, once the price falls under the parabolic line in an uptrend situation, it is ideal to close long positions. If the price climbs above the parabolic line in a downtrend situation, it is ideal to close short positions.
The importance of signals is determined through acceleration factor. The acceleration factor tends to increase when a price is higher than its former value in an uptrend situation. More so, lower in a downtrend.
To calculate the parabolic SAR, one has to multiply the difference of the high and low prices together with the latter session of SAR. The answer needs to be subtracted from the SAR of the previous session if the SAR is falling. If the SAR is rising, add the result to the value of the previous session.
P(t) = P(t-1) + AF x (EP(t-1) – P(t-1))