Parabolic Stop and Reverse is another technical indicator that is used to analyze trending markets. This indicator is similar to a Moving Average but the calculation is different and the SAR line may change its position depending on the movement of the price. The SAR line will move above the prices when the prices are falling and will move below the price when the prices are rising. As such the indicator will pause when the price line crosses the indicator and will move above or below the price line. Let's look at a graphical interpretation to understand this well.
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If you look at point "1" in the above graph you will note that the SAR is above the price line (which is a down trend) prior to that point and the as the prices starts an uptrend the SAR crosses the price line and moves below it. The opposite happens at point "2" where the price trend moves from upward to downward and the SAR crosses the price line to move above it. This happens each time the price line moves from downward to upward and vice versa.
It is considered that when the indicator or the SAR line is moving below the price line it is a bullish signal indicating that the price will continue its upward momentum. On the other hand, if the SAR is moving above the price line it is a bearish signal and the downward trend will continue.
Further, when the SAR line crosses the price line form below to above that triggers a SELL signal (as in point "2" of the graph). And as the SAR crosses the price line from above to below, a BUY signal (as in point "1" of the graph) is given as it is a time the SAR is placed at the most recent low price of the stock.
Although this method gives the investor the ability to arrive at buy or sell decisions, during a time period where there are multiple trend reversals Parabolic SAR could give false signals.
Signals of an indicator could be more useful when it is used in conjunction with other indicators and is more reliable. As such we advise you to use this indicator along with other indicators for it to be more reliable and useful.
Sri Lanka Equity Analytics
Last edited by Quibit on Wed Apr 27, 2011 7:46 pm; edited 2 times in total