First introduced by technical analyst Willes Wilder in 1978, the PSAR indicator - when used properly, gives traders a cutting edge in the market.
In this article, we'll discuss the in's and out's of this indicator and show you how you can use it as part of your trading strategy.
Why I Love the PSAR Indicator
- PSAR, short for parabolic stop-and-reverse, is not only a powerful indicator but a deadly one. As you may know, traders have 100's of indicators to choose from, but in my opinion, the PSAR is one of the best.
Profitable traders use the PSAR indicator to determine whether the current price trend will continue or reverse. But there's more, it also assists traders in determining proper entry and exit points. Keep reading, and I'll show you how!
1. Main Takeaways for Today
- The fundamental purpose of the PSAR indicator is to determine trend direction, capture reversal signals and trade entry and exit points.
- A bullish trend is characterized by a PSAR dot below a candlestick body, whereas a bearish trend is characterized by a PSAR dot above a candlestick body.
- The PSAR is fantastic for trading volatile swinging markets as it only moves in the direction of the trend.
- It performs best in markets with a steady upwards or downwards trend.
- Since the parabolic SAR tends to whipsaw back and forth in sideways trending markets, it's not wise to use it for trading signals.
2. The Basics of the PSAR Indicator
Also known as the "stop and reversal system," the PSAR indicator appears as a series of dots either on top or below candlesticks. We interpret the end result in one of two ways.
Firstly, a dot below the candlestick is deemed to be a bullish signal. Conversely, a dot above the candlestick means that the bears are in control. At the same time, you need to be careful as momentum is likely to remain downward.
3. What Happens to the Dots When the Stock Is Rising in Price?
As the price of a stock rises, so do the dots. At first, they rise slowly, then they pick up speed and accelerate with the trend.
As the trend develops, the PSAR indicator starts to move a little faster, and the dots soon catch up to the price. If can help you predict when a stock will go up.
4. What Happens When the PSAR Dots Flip?
When the dots on the PSAR indicator flip, buckle up. It means that a potential change in price direction is underway.
As a trader, this is valuable information to know for obvious reasons. If you're thinking of going long on a stock but the dots are above the price, you wait for the dots to flip.
Once the dots flip below the price, it's a strong signal of a further rise in price. Now is your time to enter.
How Is the PSAR Indicator Used in Trading?
- For proof, look no further than the following chart. When following the indicator signals properly, it would have kept you in the long trade (or out of shorts) until the pullback to the downside began. When the uptrend resumed, the indicator got the trader back in. Undoubtedly, this shows that the indicator works well for capturing profits during a trend.
1. One Great Use of the PSAR Indicator
Did you know that the PSAR indicator is a great way to set stop-loss orders? Let me explain. In a scenario where your stock price is rising, simply move your stop-loss to match the parabolic SAR indicator.
The fundamental concept applies to your short position—as the price falls, so will the indicator. All you need to do is move your stop-loss to match the indicator's level after every price bar.
2. Indicators That Compliment the PSAR
In life, it's best not to have all your eggs in one basket; the same goes for trading. Undoubtedly, it's wiser if you have a few indicators - but not too many, to confirm your trade signal than to rely solely on one specific indicator.
Many traders like to use stochastics and moving averages - the 21-day EMA to be exact, in conjunction with the PSAR indicator. Personally, these are the only three indicators I have on my chart right now.
There's no one size fits all approach; find the indicators that work for you, and you will find your profits. Let's take a look at a real-life example using moving averages in the image below.
When the price is trading above a long-term moving average, PSAR buy signals are seen as much more valid and convincing. Translated into simple language, this means the buyers are in control of the price direction.
Plus, combined PSAR buy signals can be interpreted as the beginning of another push up. Alternatively, when the price is below the moving average, your sell signals are when the dots move from below to above.
3. Some Drawbacks of the PSAR Indicator
Without a doubt, the indicator works fabulously in markets trending up and down. But, this is another story in markets that are moving sideways or choppy.
During sideways periods, the PSAR indicator gives multiple poor, false trading signals; the chart in the beginning shows this.
The parabolic SAR is worth its weight in gold as it tells us price direction along with new long or short trade signals. In a market trending strongly up or down, it works fabulously.
However, as I mentioned above, it produces many false signals and losing trades when the price starts moving sideways. To avoid this situation, only trade in the dominant trend direction when using the PSAR indicator.
Regardless of the indicators used, you need to have the knowledge behind you if you want to win at this game. Nowadays, new traders will jump in with all their cash without developing their skills.
Luckily, with Bullish Bears, our courses are free. There's no need to rush the process; take your time to build your strategy and the right indicators for you.