Parabolic indicator (sometimes referred to as SAR) was developed by Welles Wilder in 1976 and was originally called “stop and reverse”. The indicator is effective only in a trending market. It helps to define the direction of the prevailing trend and the moment to close positions opened during the reversal.
The closing price (parabolic) is calculated for each bar using the following formula:
SAR (i) = ACCELERATION * (HIGH (i – 1) – SAR (i – 1)) + SAR (i – 1)
SAR (i) = ACCELERATION * (LOW (i – 1) – SAR (i – 1)) – SAR (i – 1)
SAR (i – 1) — parabolic value on the preceding bar
ACCELERATION – acceleration factor; for the first bar it is usually 0.20, and then it is calculated as follows: AF = 0.20 + n x 0.02, where n – the number of new tops (bottoms), HIGH (i – 1) — high of the previous period, LOW (i – 1) — low of the previous period.
If a trend is bullish, SAR is below the price chart; if it is bearish, SAR is above the price chart. When the price crosses Parabolic SAR, the indicator reverses and its value becomes opposite to the price. The actual point at which the system is reversed is the high or the low of the previous period. In order to add the indicator in MetaTrader 4 use Insert -> Indicators -> Trend -> Parabolic SAR» menu sequence:
When the price chart crosses Parabolic SAR it may be a reversal signal or may indicate temporary consolidation, hence, it is considered as a classic signal to initiate a position. Parabolic SAR and trend direction are the same. If parabolic moves higher, then the trend is bullish and vice versa. If there is a significant divergence between the price chart and the parabolic, then their convergence may happen very soon. When the indicator has completely formed and the Parabolic SAR moves parallel to the price chart, most of the signals will be true; after this, they tend to contract and the number of false signals will be higher.