The Parabolic SAR explained simply

SAR stands for Stop and Reverse. J. Welles Wilder introduced the indicator in 1978. The idea: while a trend is running the stop follows along, and as soon as the price touches it, the direction flips.

What it's about

On the chart you see small dots. When they're below the price, the trend counts as up. When they're above, as down. When the price touches the dots, they jump to the other side.

An example: a stock has been rising for two weeks, the dots sit below it and move up day by day. If the price one day falls below the dot, the dots jump above the price. Anyone using the SAR as a stop would have exited that day.

How it's calculated

Each new dot is the old dot plus a fraction of the distance to the extreme so far, in an uptrend the highest high. That fraction is called the acceleration factor. It starts at 0.02 and rises by 0.02 with each new high, up to 0.2. That's why the dots close in on the price faster and faster.

With numbers: the SAR is at €48, the highest high at €53, the factor at 0.04. The next dot sits at €48 plus 0.04 times €5, so at €48.20.

What signals traders read from it

• Flip: When the dots jump below the price, some read it as a buy signal. When they jump above, as a sell signal.
• Trailing stop: Many only use the dots to move a stop up day by day during a trend.
• Distance: A wide gap between price and dots shows a strong trend.

Where it misleads you

In sideways phases the dots keep switching sides. If you trade every flip, you keep buying and selling at slightly worse prices and pay fees every time. Wilder himself recommended using the SAR only in clearly trending markets.

Because the factor rises with every new high, the dots get very close to the price in long trends. Then even a normal pullback triggers the stop, although the trend continues.

An example trade with made up numbers

Nina has €10,000 in her account and risks at most €150 per trade. The SAR dots on a stock flip below the price, with the next dot €1 below it. Nina buys at €30 and sets her stop loss at €29. With that distance, she buys 150 shares for €4,500. Costs: €1 each to buy and sell, plus about 2 cents of spread per share on each order.

If it works: The trend runs and the dots follow each day, until the price touches them at €33. Nina is €450 ahead. After €2 in fees and €6 in spread, €442 is left.

If it goes wrong: The stock moves sideways and the price touches the dots the very next day. The stop fills at €28.95. That's a €157.50 loss, €165.50 with costs.

Nina mainly used the SAR as an exit. That works well in a trend. In a sideways phase, the dots sitting so close to the price is exactly what costs money.