Parabolic SAR

In today's lesson we will be analysing the Parabolic SAR. The Parabolic SAR method was developed by J. Wells Wilder in his book “New Concepts in Technical Trading Systems” released in 1978. SAR stands for 'stop and reversal' and the term parabolic comes from the shape of the curve (resembling a parabola) created on the technical chart. This trading technique is purely mechanical and therefore takes out the human emotional element that is beneficial for new traders and the seasoned campaigner alike. This charting technique should only be employed in trending markets because only then can it provide useful entry and exit signals. It goes without saying that this technique is not suitable for sideways moving markets.

Application

The following rules apply with respect to the Parabolic SAR:

• Bullish when the SAR is below a price
• Bearish when the SAR is above a share price

The most difficult part of using this technique is identifying whether or not the share price is trending or moving sideways. It's often said that 'the trend is your friend', however how do you identify this? Some chartist will identify that a stock is trending if it continues in one direction without breaking through the final Fibonacci Retracement level. Others will only start using this technique if the chart has broken through previous highs, that is, a breakout occurs.

Further refined, some analysts state that if the Parabolic SAR starts whipsawing around more than twice in a short period of time then they will not trade the stock using this technique. 

Like all technical tools, it is best used in conjunction with other techniques, such as a moving average. Some chartists will not follow a SAR signal if the Moving Average is sloping in the opposite direction. Whatever method is used it's important to state that this technique works well for stocks involved in commodities and biotechnologies. These particular stocks have a tendency to rise exponentially, and this technique can identify an early reversal signal.

Example

The chart below is of Jubilee Mines, JBM, from May 2006 to early April 2007. There are a number of other indicators placed in the chart other than the Parabolic SAR, the blue dotted line. The lower section of the chart is MACD while the 14 Day EMA (Exponential Moving Average) line is the brown line running through the share price 'candles'.

The yellow areas above highlight our first buy signal. As you can see the Parabolic SAR changed from above the share price to below. During the same time the MACD crossed over from below zero and the share price moved above the EMA line.

The aqua areas highlight the first sell signal. Notice that the SAR moved from sell to buy in a short period of time. The Parabolic SAR is indicating a similar buy signal to the one in late May 2006.