Good day everybody,
Welcome to CryptoGod-1's blog on all things crypto. Today we are going to continue the series on Technical Analysis and why it can be such an important asset for new or experienced traders. In this series I am covering some of the different Technical Analysis and Indicators which can be used to help determine market movement and sentiment when trading. For Part X the focus will be on The Parabolic SAR Indicator.
The Parabolic SAR Indicator
The Parabolic SAR indicator was developed by J. Welles Wilder Jr, creator of the relative strength index (RSI), and is used by traders to help determine the direction of an assets price. It is also used to signal entry and exit points on a candlestick chart, and is used by traders to determine potential reversals in price direction. SAR makes use of the 'stop and reverse' method, therefore it can identify suitable entry and exit points. It is placed on the candlestick chart, generally as dots, which sit above or below the price action. When a dot is placed below the candle the price is trending upwards, and when the dot is placed above the candle the price is trending downwards.
Calculating a Parabolic SAR
To calculate the Parabolic SAR a trader use the Parabolic SAR formula, which is as follows:
SARNEW = SARCURRENT + [AF x (EPCURRENT - SARCURRENT)]
AF = Acceleration Factor = this is a changing value which increase in increments for each specified period when a new high for long positions, and new low for short positions, is achieved.
EP = Extreme Point = this is the highest or lowest price point seen during the current trending period (highest in an uptrend and lowest in a downtrend)
The Parabolic SAR is shown as a curve on the chart, which is intended to provide a guide in terms of how the market is trending. In terms of the AF, Wilder proposed a value of 0.02 for the starting point with increases of the same amount.
How to use a Parabolic SAR
When a trader makes use of a Parabolic SAR for technical analysis, there are guidelines as per Wilder's strategy which must be followed:
The SAR dots beneath the current market price indicate that the asset is in an uptrend
The SAR dots above the current market price indicate that the asset is in a downtrend
Entry points are indicated which the price moves through the Parabolic SAR - buy when it crosses above the SAR and sell when it goes below the SAR
Positions should be closed and reversed when the market price cross the Parabolic SAR once again
The Parabolic SAR is shown as a dot on the candlestick chart, often in a series of dots which include slight increases as the price moves. As noted above, there are two positions for the dot on the candlestick chart, above and below the market price. The dot above the market price indicates a bearish sentiment, while the dot below indicates a bullish sentiment. When the price moves through the SAR, it flips, meaning if the SAR had been below the market price (indicating a bullish trend) and the price crosses the SAR dot, the dot will then go above the market price and indicate a bearish trend has begun.
When the market price of an asset is in a bullish trend and the price is rising, the SAR dots will also rise along with it. Generally they rise slowly and then generate momentum along with the trend, although a sharp spike in price action can result is a fast rising SAR from the outset. The idea is that the dots will catch up with the price, and as the trend slows down and begins to reverse, the market price will cross over the SAR dots and indicate a reversal is taking place.
This indicates that the SAR dots will move in a curves, which is intended to indicate the trend of the market. Wilder conceived that a trending market will generally have a large probability of remaining within the constraint of the curve on the candlestick chart, but if the price does cross over the curve of the SAR dots, the trend may be ending and a reversal trend beginning.
Traders can also use the Parabloic SAR as a method for setting up their stop loss orders. If a trader has entered a long position and the SAR is below the market price of their asset, a trader can use the SAR dot as a position to set their stop loss. As the price increases, the dot will also increase, meaning the trader can change their stop loss to match the new SAR dot. The same applies for a short position, which would see the SAR dot moving down along with the price action, and the SAR dot level should be set as a stop loss. The stop loss order should be changed after each candlestick closes as the next candlestick will show the SAR dot in a different position.
Below is an example of the BTC/USDT 1hour trading chart from Binance. Within it I have shown the 200 EMA in yellow to help give a wider indication of the general trend. The Parabolic SAR is shown as the white dots above and below the candlesticks.
The area highlighted in blue shows where the Parabolic SAR changed, and indicated an uptrend. The price however did not have strong momentum and quickly began to fall. This was a false signal with the Parabolic SAR as any long trade entered here would not have been profitable.
The area highlighted in orange shows where the price was in a range and moving sideways. The SAR was above the candlesticks, but was falling very slowly as the price was not showing much change.
The area highlighted in pink shows where the price flipped once again and signalled a reversal in the trend as the price began to fall sharply. The SAR had a very steep decline because of the amount of red candles and the level of change in price during this time.
The area highlighted in red shows where the price began to rise again, initially slowly. While the price was rising slowly the SAR was rising slowly, but as soon as large price action began there was a steep rise in the SAR.
Limitations of a Parabolic SAR
There are many benefits as mentioned above to using a Parabolic SAR, but due to the fact it is a mechanical indicator there will be constant new signals given for long and short positions. The trader needs to be aware of this and that sometimes it is only a small correction in price before the SAR dot flips once again. By following the Parabolic SAR only, a trader will result in a high number of trades. It can therefore be beneficial to make using of a moving average along with the SAR to give a higher indication of the existing trend.
The SAR is best used for high-momentum trading, or in markets with a steady trend. When the market is in a range, the SAR will generally flip between long and short signals as the price bounces. This can be a useful indicator along with Bollinger Bands for generating a number of quick trades during a ranging market. The drawback is the SAR can often produce false signals in this type of market, which is why additional TA is required.
As the SAR is constantly changing with every new candlestick, it will always be giving out new signals. This will happen even where there is no strong trend and should be considered as poor quality signals as the SAR is not following any specific trend in that moment. The same applies for using the SAR when setting stop losses, as the false signals can result in loosing trades in a non trending market. Users are advised to only trade in the direction of the current dominant trend to filter out these false signals.
Conclusion on using a Parabolic SAR for TA
As a trader, whether it be day trading or long term trading, using the Parabolic SAR indicator can be very beneficial in spotting the overall direction of a tend, while also indicating any potential upcoming changes to the trend. The SAR is shown as dots on the candlestick chart, and sit either above or below the market price. A dot below the market price can indicate a bullish trend, while a dot above will indicate a bearish one. When the price cross the SAR dot, the dot will flip and indicate that a reversal is underway. It is important to understand the overall market trend of an asset and advisable to make use of the SAR only in the current trend direction. The SAR can also be used for stop losses, but setting the stop loss price to the level of the dot, and changing it accordingly as the price moves with the trend. Traders should be aware that false signals can be commonplace with the SAR, as the price will cross beyond the dot a number of times during a trading period. Therefore the Parabolic SAR indicator should not be used as a standalone indicator, instead it should be used in conjunction with other indicators to give stronger results and more reliable signals, especially trend indicators.
As stated whether you are experienced or new, Technical Analysis can always be a useful asset when trading. Just remember it is not guaranteed and nobody can predict the future, no matter how certain you believe the patterns to be. It is always just another tool of the trade to help make more informed decisions when trading. It can be easy to get caught into false signals with a large number of dot flips and the Parabolic SAR indicator can show an upcoming trend reversal which never takes place.
It is important to use the Parabolic SAR indicator along with other TA to get the correct signals for understanding the strength of a trend. Always zoom out, if trading on a 15 minute chart check the 1 hour or 4 hour or even 1 day chart to give you a better idea of the overall trend strength via the Parabolic SAR indicator, along with checking the trend strength of the larger overall trend compared to short term ones.
You can find the previous parts to the series here:
Technical Analysis - Part I - Exponential Moving Average (EMA)
Technical Analysis - Part II - Relative Strength Index (RSI)
Technical Analysis - Part III - Bollinger Bands (BB)
Technical Analysis - Part IV - Moving Average Convergence Divergence (MACD)
Technical Analysis - Part V - On-Balance Volume (OBV)
Technical Analysis - Part VI - The Average Directional Index (ADX)
Technical Analysis - Part VII - The Aroon Indicator
Technical Analysis - Part VIII - The Accumulation/Distribution Indicator (A/D)
Technical Analysis - Part IX - The Supertrend Indicator
Also feel free to check out:
I hope this post was beneficial and of some use, and I plan on continuing the series with the next instalment focusing on determining support and resistance levels. Of course each technical analysis provides different beneficial information, so combining your most trusted and favourite ones can be the best strategy for finding entry and exit points when trading.
Have a great day.
Peace. CryptoGod-1.
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