The Parabolic SAR was originally created by the now famous technician Welles Wilder, who also happens to be the creator of the relative strength indicator. The Parabolic SAR is technical indicator which is used to determine the direction of an instruments price movement. While also being used to determine when this momentum as displayed by the indicator has a high probability of switching direction. This has led the Parabolic SAR to become known as the stop and reversal indicator.
The indicator is pretty simple to understand. Dots above the price are taken to be a bearish sign and dots below the current price are taken to be a bullish sign. As you can see on the chart above the Parabolic SAR lies below the price for a bulk of the chart which see’s a sustained rise in the price of the stock in question. It is also taken that the narrowing of the gap between the dot and the actual price represents as a sign that the current trend is about to end, with a switch momentum being a distinct possibility. It is important to take a minute to note that the Parabolic SAR is an accelerating system which allows a trader to watch a trend develop and establish itself in real time, while this works very well when there is a strong trend occurring. But the relationship seems to break down in sideways market places which sees the Parabolic SAR producing many fake signals.
While the Parabolic SAR is a favorite among many traders, partly due to it’s simplicity, it is often used in conjunction with technical indicators. This is in part to due the fact that the Parabolic SAR is known to provide it’s user with some false signals. One suggested signal to be used in conjunction with the Parabolic SAR indicator, is a relatively long term moving average as this can help establish trends more accurately. Though a variety of indicators have been suggested to be used alongside Parabolic SAR with various positives and negatives.