The parabolic SAR is a popular indicator that is mainly used by traders to determine the future short-term momentum of a given asset. The indicator was developed by the famous technician known as Welles Wilder and can also easily be applied to a trading strategy, enabling a trader to determine where stop orders should be placed. The calculation of this indicator is rather complex and goes beyond the scope of how it is practically used in trading.
One of the most interesting aspects of this indicator is that it assumes that a trader is fully invested in a position at any 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.
The parabolic SAR indicator is graphically shown on the chart of an asset as a series of dots placed either above or below the price (depending on the asset’s momentum). 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 you can see 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 as it was earlier.
As you can see from the right side of the chart, using this indicator by itself can often lead to entering/exiting a position prematurely. Many traders will choose to place their stop loss orders at the SAR value because a move beyond this will signal a reversal, causing the trader to anticipate a move in the opposite direction.