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9.7 Parabolic SAR

Parabolic stop and reverse (SAR) by J. Welles Wilder is a trend following system which establishes a trailing stop that’s progressively advanced as a price move continues. If penetrated then one’s position short or long is reversed and a new stop established for the move in the opposite direction.

The stop is calculated as follows. For an upward move, the initial SAR is the lowest low made in the preceding down movement. From there an extreme high of the current move is maintained and the stop advances towards that by a fraction called the “acceleration factor”.

SAR = SAR[prev] + accel * (extreme - SAR[prev])

The initial acceleration factor is 0.02, and each time a new extreme is made, ie. a new high, it’s increased by adding 0.02, up to a maximum of 0.2. (Those values are parameters in Chart.) The effect is to move the stop up faster in a strong move making successive new highs.

If the SAR for a given day is penetrated by any part of that day’s trading range then it’s a signal to reverse one’s position and the SAR becomes a trailing stop for a short. The calculation for that is the same, using the previous extreme high as the initial stop and maintaining a low to step towards. Reversals can be seen in the graph when the stop mark switches from above to below the prices, or back.

This approach is only suited to trending markets. If prices are chopping back and forward in a ranging market then a lot of whipsaw reversals are generated. At each reversal the new stop point can be quite a distance from the current prices, ie. one’s entry point, making those whipsaws expensive. Wilder believed markets trend only about 30% of the time. His ADX (see Directional Movement Index) is one way to identify such conditions.

In Chart the default is not to adjust for dividend payments in the display or in indicator calculations. If price falls on ex-dividend dates are causing unwarranted SAR reversals you can turn on the adjustment option in the view style (see View Style). (Assuming the data source provides dividend information.)

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