In the field of
technical analysis, Parabolic SAR (SAR - stop and reverse) is
a method devised by J. Welles Wilder, Jr, to find trends in
market prices or securities. It may be used as a trailing stop
loss based on prices tending to stay within a parabolic curve
during a strong trend.
The concept draws on the idea that time is an enemy, and
unless a security can continue to generate more profits over
time, it should be liquidated. The indicator generally works
well in trending markets, but provides "whipsaws" during
non-trending, sideways phases. A parabola below the price is
generally bullish, while a parabola above is generally
bearish.
The Parabolic SAR is calculated almost independently for each
trend in the price. When the price is in an uptrend, the SAR
appears below the price and converges upwards towards it.
Similarly, on a downtrend, the SAR appears above the price and
converges downwards.
At each step within a trend, the SAR is calculated ahead of
time. That is, tomorrow's SAR value is built using data
available today.
The extreme point, EP, is a record kept during each trend that
represents the highest value reached by the price during the
current uptrend — or lowest value during a downtrend. On each
period, if a new maximum (or minimum) is observed, the EP is
updated with that value.
The α value represents the acceleration factor. Usually, this
is set to a value of 0.02 initially. This factor is increased
by 0.02 each time a new EP is recorded. In other words, each
time a new EP is observed, it will increase the acceleration
factor. This will then quicken the rate at which the SAR
converges towards the price. To keep it from getting too
large, a maximum value for the acceleration factor is normally
set at 0.20, so that it never goes beyond that.
The SAR is recursively calculated in this manner for each new
period. There are, however, two special cases that will modify
the SAR value:
If tomorrow's SAR value lies within (or beyond) today's or
yesterday's price range, the SAR must be set to the closest
price bound. For example, if in an uptrend, the new SAR value
is calculated and it results to be greater than today's or
yesterday's lowest price, the SAR must be set equal to that
lower boundary.
If tomorrow's SAR value lies within (or beyond) tomorrow's
price range, a new trend direction is then signaled, and the
SAR must "switch sides."
Upon a trend switch, several things happen. The first SAR
value for this new trend is set to the last EP recorded on the
previous trend. The EP is then reset accordingly to this
period's maximum. The acceleration factor is reset to its
initial value of 0.02. |
