What is psar in stock market?

Shabbir Kayyumi

The parabolic SAR is a technical analysis indicator that sets trailing price stops for long or short positions and assists traders in selecting an entry and exit points. The indicator is also referred to as a stop and reverse system, which is abbreviated as SAR.

J Welles Wilder created the Parabolic SAR (SAR) and featured it in his book 'New Concepts in Technical Trading Systems'. The book was published in 1978 and also featured several of his now classic indicators such as The Relative Strength Index, Average True Range and the Directional Movement Index.

What is 'Parabolic SAR'?

Parabolic SAR was originally named "Parabolic Time/Price System" with SAR an acronym for "stop and reverse". Technical analysts often refer to the indicator as simply "SAR" or "PSAR".

It finds the potential reversals in the price of traded assets such as securities and currency & commodities and can be used to provide the entry and exit points.

One of the most interesting aspects of this indicator is that it assumes that the trader is fully invested in a position at all point in time. For this reason, it is of specific interest to those who develop trading systems and traders who wish to always have money at work in the market.

Construction of Parabolic SAR Indicator

The PSAR indicator is somewhat complex to calculate by hand and most traders simply use trading software to chart it. Parabolic SAR (SAR) is a time and price technical analysis tool primarily used to identify points of potential stops and reverses.

When graphically plotted on a chart, the Parabolic SAR indicator is displayed as a series of dots. When it appears above the price bar, the parabolic SAR is interpreted as a bullish signal, whereas when it is positioned below the price bar is deemed to be a bearish signal. The signals are used to set stop losses and profit targets.

Working of Parabolic SAR Indicator

> A small dot is placed below the price when the trend of the asset is upward, while a dot is placed above the price when the trend is downward. As can be seen from the chart below, transaction signals are generated when the position of the dots reverses direction and is placed on the opposite side of the price.> When the price of a stock rises, the dots also rise. The rise is slow at first, and the pace then accelerates with the trend, before catching up with the asset price. The Parabolic SAR works well for capturing profit targets by entering the trade during a trend in a steady market.> The change in the direction of the dots produces trade signals, which can produce a profit when the price makes big swings. However, if the price moves sideways, it can produce continuous losses or small profits, especially in an unsteady market.> The parabolic SAR performs best in markets with a steady trend. In ranging markets, the parabolic SAR tends to whipsaw back and forth, generating false trading signals.> Parabolic SAR creates a parabola on the chart. The parabola is always below the price in an uptrend and above the price in a downtrend.> Traders may also use candlestick patterns or moving averages for better results.> The indicator can also be used to set stop loss orders. It can be achieved by moving the stop loss to match the level of the SAR indicator.> Extreme Point: The extreme point is the highest high of an uptrend and the lowest low of a downtrend. The difference between the previous extreme point and the previous PSAR is the value that is multiplied by the acceleration factor to determine the change in PSAR with each round of calculation. Thus, a larger deviation in the extreme point from the Parabolic SAR will result in a larger movement of the current PSAR towards the current stock price.

> Maximum Step: The maximum step is the maximum value that the acceleration value is allowed to reach. That is, once the acceleration reaches the maximum step – typically set to 0.20 – it will remain at that value until the trend reverses and the acceleration factor resets to its initial value. A lower maximum step makes the PSAR less likely to signal a reversal, since it limits the acceleration on the PSAR, while a higher maximum step can make the PSAR more likely to signal a reversal.

Trading Technique:

Trading with ADX

The Parabolic SAR mainly works in trending markets, and Wilder recommends that traders should first establish the direction of the trend using a parabolic SAR and then using alternative indicators to measure the strength of the trend. We have used ADX, +DI & - DI indicator for considering the strength of the trend with parabolic SAR.

Buying with SAR1. ADX trading above (20).2. +DI is greater than – DI3. Parabolic SAR point is below candle (bullish signal

Selling with SAR1. ADX trading above (20).2. -DI is greater than + DI3. Parabolic SAR point is above candle (bearish signal)

Rather than putting in one stop loss below where a trader entered a long position or above where the trader entered a short position, using the Parabolic SAR as a trader's guide, the stop loss is gradually raised for a long position and lowered in a short position, effectively locking of profits. It acts as a time stop too. Traders should use the SAR in conjunction with other technical indicators to maximize their odds of success.

Parabolic SAR is also known as the Parabolic Stop and Reverse was developed by J. Welled Wilder.

This is a trend following indicator that is displayed as dots underneath the price bars in the case of the uptrend and above the price bars in the case of a downtrend.

Let us discuss the basics of this indicator and then how to use this indicator in our trading:

It is a trend following indicator that is popularly used by the traders to set trailing stop losses.

The Parabolic SAR has three main functions. Firstly, it highlights the current trend or price direction.

Secondly, it provides potential entry signals, and lastly, it provides potential exit signals.

Dots that form below the price and are rising in an upwardly sloping pattern signals an uptrend.

Whereas, the dots that form above price and are falling in a downwardly sloping pattern signals a downtrend.

The Parabolic SAR (PSAR) indicator uses the recent extreme price (EP) with an acceleration factor (AF) for determining where the indicator dots will appear.

It is calculated as follows:

This calculation creates a dot that can be connected with a line, below the rising price or above the falling price.

The dots are always present; this is why this indicator is also known as “stop and reverse.”

The Parabolic SAR performs well in the trending markets.

In the consolidating markets, the parabolic SAR tends to whipsaw back and forth, and thus generate false trading signals

The main use of this indicator is to buy when the dots move below the price bars that signals an uptrend.

And sell when the dots move above the price bars signaling a downtrend.

Example:

From the Daily chart of Reliance Industries Ltd. below, we can see that how in the consolidating market the parabolic SAR tends to whipsaw back and forth, and thus generate false trading signals.

Whereas in the trending markets, it is giving a clear signal of buy and sell.

One should short the stock when the dots turn above the price which signals that the trend is going to reverse in the downtrend as shown above.

One should buy it when the dots turn below the prices, indicating the trend is going to reverse in the uptrend.

Traders can use other indicators like the average directional index momentum indicator for confirming the strength of the existing trend.

Other indicators complementing the SAR trading signals include moving averages and candlestick patterns.

The main benefit of this indicator is that, during a strong trend, the indicator highlights that the trader should keep holding his position.

The indicator also gives an exit when there is a move against the trend, which signals a reversal.

The main drawback of this indicator is that it doesn’t provide good trade signals during sideways market conditions.

Without a clear trend, the indicator constantly flip-flops above and below the price.

You can also use the Parabolic SAR Scans in the StockEdge web version as shown below:

Steps to use Parabolic SAR scans in StockEdge:

• The SAR dots beneath the current market price point to an uptrend;
• The SAR dots above the market price point to a downtrend;
• Enter a position when the price penetrates the SAR – buy if the price crosses above the SAR and sell if the price crosses below the SAR;

Traders also refer to the indicator as to the parabolic stop and reverse , parabolic SAR, or PSAR. The parabolic SAR indicator appears on a chart as a series of dots, either above or below an asset's price, depending on the direction the price is moving.

The Parabolic Stop-and-Reverse (PSAR) indicator places a set of dots on a chart in order to highlight whether a stock is trending up or down and to indicate when a price trend breaks ahead of a potential reversal. PSAR was developed by Welles Wilder in 1978 and has remained popular among traders ever since as a tool for identifying price trends as well as potential entry and exit points. When used in combination with other indicators to confirm potential reversals, PSAR can be a powerful indicator for trading trending stocks.

PSAR is a trend following indicator, essentially trailing behind price during a trend to indicate the direction of a price trend. If PSAR is less than the stock price over repeated time intervals it indicates that the stock is trending upward, while if PSAR is greater than the stock price it indicates that the stock is trending downward. The power of PSAR is that it can foretell reversals if its value flips from below the stock price to above it or vice versa.

PSAR is particularly difficult to calculate by hand because it depends on whether the value of PSAR itself is rising or falling and includes an acceleration factor that changes with each time interval in the current trend. The acceleration factor is an important component in calculating PSAR – typically, it is initialized with a value of 0.02 and increases by a value of 0.02 every time the stock price reaches a new highest high or lowest low in the current trend up to a maximum value of 0.20.

If the stock price, and consequently PSAR, is trending upward, PSAR is calculated by subtracting the last time period’s PSAR from the highest high in the uptrend, multiplying that value by the acceleration factor, and then adding the result to the previous period’s PSAR. Thus:

PSAR (uptrend) = Previous PSAR + Acceleration Factor*(Highest High – Previous PSAR)

If the stock price and PSAR are trending downward, the calculation for PSAR is somewhat different. To calculate PSAR, subtract the lowest low of the current downtrend from the previous time period’s PSAR (the opposite of the subtraction for an uptrend), multiply the result by the acceleration factor, and add this to the previous PSAR. Thus:

PSAR (downtrend) = Previous PSAR + Acceleration Factor*(Previous PSAR – Lowest Low)

It is also worth noting that PSAR cannot be above the lows of either of the previous two time periods in an uptrend, or below the highs of the previous two time periods in a downtrend. In these cases, use the lowest of the two lows or the highest of the two highs as the new PSAR value.

The acceleration factor is the primary variable in the calculation of PSAR that can be manipulated to achieve different effects with the indicator, and particularly to tune the sensitivity of PSAR and its propensity to flip from uptrending to downtrending and vice versa. PSAR sensitivity can be decreased by reducing the change in the acceleration factor with each new high or low and increased by increasing the change in the acceleration factor with each new high or low. Thus, a step of 0.01 in the acceleration factor will produce less reversals in PSAR, while a step of 0.03 will produce more. Be careful with the latter, as it can cause PSAR to reverse too frequently rather than actually follow trending price action.

Another way to fine-tune the acceleration factor is to change its maximum value. A lower maximum value, for example 0.10, will produce fewer reversals than a higher maximum value. Changing the maximum value of the acceleration factor has less of an immediate effect, and less of an effect on short trends, than changing the step.

When PSAR, typically plotted as a series of dots on a chart, is below the stock price over a set of intervals, that indicates that the price is trending upward. When PSAR is above the stock price, it indicates that the price is trending downward. The key to PSAR is that when its value flips from greater than the stock price to less than the stock price, or vice versa, it may indicate that a reversal has taken place or is about to. PSAR flips can thus signal entry and exit points to capture the bulk of a trend but to exit before the reversal fully takes hold.

When trading with PSAR, the most important thing to remember is that it is only effective as a buy and sell indicator for swing trading when a stock is trending strongly. In a sideways market, PSAR will flip above and below the stock price repeatedly and it may be difficult to identify true signals without using additional indicators such as MACD, RSI, moving averages, and others. A PSAR breakout is much more convincing when, for example, a stock is considered oversold by RSI or is valued below a long-term moving average. Trendlines and moving averages can also help to determine when a strong trend is present as opposed to highly volatile or sideways price action, and manipulating the calculation of PSAR using the acceleration factor as described above can help to minimize fall signals.

One of the best and most popular uses of PSAR is to set stop losses during a trend. As the price of a stock trends upward, it is important to protect profits by continuously adjusting stop losses upward. The PSAR represents a choice value for stop losses at the end of each time interval since if the price breaks below the PSAR it is likely indicating a reversal and the PSAR will flip from below to above the stock price accordingly. For downtrending stocks, PSAR can also be used to protect profits when short-selling by similarly setting the PSAR as an exit point if the price of the stock exceeds its value.

The PSAR is most similar to the MACD in that they are both trend following indicators and both can indicate a potential reversal – PSAR by flipping from below to above the stock price or vice versa, and MACD by exhibiting a signal line crossover. MACD can also, like PSAR, give information about the direction of a price trend based on whether its value is positive or negative. However, MACD does not provide price information that can be used to set stop losses or profit protections in the same way that PSAR does.

The first example shows the power of PSAR to be used both for indicating reversals and for setting trailing stops. Both reversals on the chart are captured accurately by PSAR since this stock is trending strongly over the period in question. Notably, the second, larger reversal is also signaled by a signal line crossover in the MACD chart to confirm the exit signal from PSAR. Most important, traders who are using PSAR to set trailing stop-losses while following the two uptrends would have been rewarded – these stop losses would have protected the bulk of profits from following the uptrends, whereas leaving stop losses at levels near the start of the uptrends would have negated nearly all profits.

The second example shows a situation in which PSAR is not nearly as effective and must be interpreted with caution – volatile, sideways price action. In the absence of strong trends, PSAR values may flip erroneously and the price trends indicated by PSAR may be unfounded. There are numerous examples in this chart (a few are noted) where trading on PSAR alone would lead to s. In this situation, it is possible to desensitize PSAR by lowering the acceleration factor step, although PSAR is in general not the indicator of choice for trading during periods of sideways price action.