Analyzing crypto markets using technical analysis is indeed the most preferred mETHod for speculating on crypto prices. Among the several subdomains in technical analysis, technical indicators are a highly rated tool. With the advent of computer algorithms, analyzing past prices in different ways has become an efficient way for short-term traders to leverage their market analysis.
With various technical indicators in the market, the Parabolic SAR indicator is one of the most preferred by technical analysts. The calculation and derivation of the indicator are unique and powerful, making it a reliable trading indicator to speculate the price movement. This guide will dive into how do you use Parabolic SAR effectively and discuss 2 parabolic SAR strategy using this technical tool.
What Is the Parabolic Stop and Reverse Indicator?
The Parabolic SAR indicator is a technical indicator that helps predict upcoming market reversals and the possibility of current trend continuations. It works by helping traders forecast both bearish and bullish reversals and helps analysts gauge if markets continue in the same predominant direction. In addition, the indicator can help traders time their signals and steer away from false signals to know when exactly to go long or short.
Years ago, the indicator was embedded in the PSAR strategy as the Parabolic Time/Price System. The abbreviation SAR meant the points at which traders must enter with long positions and exit trades with short positions and vice versa. It is currently known as the Parabolic SAR indicator, providing buy and sell entry points and forecasts on trend continuation, market reversals, and even breakouts.
Calculating the Parabolic SAR Indicator
With recent technological advances, the indicator is readily available for application in several trading consoles as computers have automated the calculation of the Parabolic SAR. However, to understand how the indicator is developed, here is a brief explanation of its calculation.
Stop, and Reverse (SAR) points are calculated from existing market data. For example, to calculate today’s SAR, yesterday’s SAR is used, and today’s value is used to calculate tomorrow’s SAR value.
In an uptrend, the SAR value is derived from its previous highs. For downtrends, the value comes from the previous lows. The highest and lowest points of the trend direction are referred to as extreme points (EP).
The formula used to calculate SAR value is as follows:
- Uptrend Parabolic SAR = Prior PSAR + Prior AF × (Prior EP – Prior PSAR)
- Downtrend Parabolic SAR = Prior PSAR – Prior AF × (Prior PSAR – Prior EP)
AF is an abbreviation for the acceleration factor. It begins with 0.02 and varies based on new highs and lows set by the market. By default, whenever a new high or low is reached, the AF is increased by 0.02. However, the value caps out at 0.2 until the market reverses direction. Again, EP stands for the extreme point in either an uptrend (highest point) or downtrend (lowest point).
Moreover, traders can vary the capped value of AF to alter the indicator’s sensitivity. If the factor is set higher than 0.2, then the sensitivity increases, presenting more reversal signals. Similarly, an AF set lower than 0.2 will decrease the sensitivity and provide fewer trend reversal signals.
How Do You Use Parabolic SAR Effectively?
Parabolic SAR is one of the most powerful indicators in the market. But that doesn’t mean its implementation is difficult. PSAR is simple both to apply and to use in predicting the market.
As mentioned earlier, the Parabolic SAR identifies the market’s trend and presents potential entry and exit points for traders to profit. When applied, a sequence of dots runs above and below the price (candlesticks). Generally speaking, a dot below the candle is a signal of an uptrend, while a dot above the candle is a sign that the market could head south.
The PSAR can also be used to set stop-loss orders. It is more like a trailing stop, where traders match the stop-loss price with the SAR dots when the price movement rises or falls. As a result, traders can lock the profits they’ve made before the market reverses its direction.
When to Use Parabolic SAR in Crypto Trading
The Parabolic SAR indicator has great benefits if it is understood and used at the proper moments. And since its features go hand in hand with crypto markets, the PSAR is a crypto analyst’s favorite.
Many traders have the misconception that the PSAR indicator can be applied and interpreted in all markets. But the indicator generally provides efficient results in markets with a dominant trend. Since crypto markets are known for their long-lasting trending phases, this makes the PSAR an ideal choice for technical analysts.
2 Parabolic SAR Strategy
Strategy 1: EMA with PSAR Crypto Trading Strategy
Incorporating the exponential moving average (EMA) with the PSAR is one of the most reliable strategies. The strategy is based on EMA crossover either above or below the price action. Following is an example of this concept.
For instance, a chart of BTC/USDT on the 1H time frame depicts the MA and the PSAR dots below the price action in the beginning. Later, the market dot switches from the bottom of the price action to the top, indicating a reversal in the market. But instead of going short right away, we wait for the EMA crossover. As the price drops below the EMA, we can trigger a sell signal.
- Trade Management
Stop Loss
The stop loss can be placed above the EMA crossover or above the highest PSAR dot, to be on the safe side. One can even trail as the market begins to perform in the desired direction.
Take Profit
The trade can be left running as long as the dots are above the price action. Additionally, traders can book some profits along the way at potential support levels.
Strategy 2: Price Action Trading Using PSAR and Trend Lines
The Parabolic SAR is known for identifying trending markets. But it can also be used to identify trend lines for incorporating price action concepts.
In an uptrend, the market progresses, with higher highs and higher lows. As it is challenging for traders to spot the higher lows to draw the trend line, the SAR dots come in handy. Simply joining the progressive dots lying below the price action leads to a perfect trend line. If we were to trade using the price action approach, traders could catch hold of a buy position at either the Support & Resistance (S&R) level or at the bottom of the trend line.
- Trade Management
Stop Loss
A stop loss below the recent SAR dot or S&R is ideal to avoid getting stopped out.
Take Profit
It is ideal for liquidating all positions when the PSAR shows signs of reversal by putting in dots above the candlesticks.
Closing Thoughts
The Parabolic SAR indicator was developed by the same analyst who created the powerful RSI oscillator indicator. Its primary purposes are identifying potential reversals, spotting a new trend or identifying trend continuation, and precision entries. It is an extensively used and trusted indicator to identify an enter and exit signal.
All in all, the Parabolic SAR does help to prepare traders for a contingency plan in case the price falls. However, PSAR shouldn’t be used when the market is moving sideways as this indicator thrives in a trending environment – which you should now know having finished this article on how do you use Parabolic SAR effectively.
