Trading Parabolic SAR in Forex
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Parabolic SAR is a great indicator to use for getting into trends. Once loaded, it will appear in the price window rather than a separate technical indicator window below the price chart. At a first glance, it may even look a little strange because it provides us with dots above and below our candlesticks. There is logic behind these dots. When the dots appear above candlesticks the Parabolic SAR is giving us a SELL signal. When they are below the candlesticks it is telling us to BUY. That is as complicated as this technical indicator gets.
However, Parabolic SAR cannot be used on its own. The reason why is because we need more of a confirmation that a trend is taking place; so far all we have is a buy or a sell signal. This is why we need to combine it with another indicator such as the Momentum indicator. Average directional index (ADX) or any other indicator can also be used as long as they provide an indication that a trend is taking place. Once the momentum indicator shows us a reading over 100 in an up-trend or below 100 in a down-trend, we combine it with a relative reading from the Parabolic SAR. So, in an up-trend we need the dots to be below the candles and in a down-trend we need the dots to be above our candles. Once this combination is correct, we trade.
There are a couple of scenarios where the Parabolic SAR cannot be used. The first is when we have a range-bound market. This is when the market is trendless. It literally bounces around with no sense of direction. Despite this lack of trend, Parabolic SAR will still produce the dots but we must ignore the indicator here because it only works in a trending market. By simply identifying with a naked eye that there is no trend, we ignore the set-up.
The second scenario is when we have dots on each side of our candlesticks at the same time. This is when the Parabolic SAR has no sense of direction so we have to wait until a dot appears on one side only.
Using Parabolic SAR as a stop loss
When we trade trends we usually put a stop loss at the previous or a relative new higher low (when going long) or lower high (when shorting). This is a great way to trade but this can stop us out of a trade too early. By placing a stop loss below the Parabolic SAR dots in an up-trend or above the dots in a down-trend, we give our prices a lot more room to manoeuvre. This allows us to stay in a trend much longer and generate higher profits.
Parabolic SAR combined with the Momenum indicator can give us reliable selling/buying signals and confirmation of trend direction.