How Day Traders Ride Intraday Trends Using Parabolic SAR
The Parabolic SAR (stop and reverse) is one of the most popular and potent technical indicators in the arsenal of a day trader. Although it can be used as a completely mechanical trading system, the Parabolic SAR works best during trends. It is during strong trends that the Parabolic SAR enables a trader to stay in the trade and not get shaken out too early. It is beyond the scope of this article to cover how the Parabolic SAR is calculated, go to Parabolic SAR Wikipedia instead for more information.
Parabolic SAR Trading Signals
The way the Parabolic SAR was designed is to use the price crossover of the SAR as a place to position stop orders either to initiate or exit a trade. The rule is therefore such:
- Close longs or go short when the price falls below the SAR
- Close shorts or go long when the price rises above the SAR
Riding The Trend With Parabolic SAR
As you can see, it is a very simple TA system but the fact of the matter is that in real trading, this indicator can get whipsawed badly. The Parabolic SAR performs poorly in trading ranges and should only be used during strong trends. Confirming a trend with other trend following indicators like MACD and ADX is essential. This combined with a robust entry system using momentum oscillators will allow the trader to find good entry points in the direction of the trend. Momentum indicators like Stochastics and RSI are very good at identifying entry signals during retracements, after the general trend has been identified.
Once a position has been initiated, a trader can use a trailing stop with the Parabolic SAR and ride out the trend. Nimble scalpers may also exit and re-enter trades based on momentum oscillator signals in order to maximize the profit potential of the trend, but this is only for the very experienced as it could mean exiting a trade too early and not being able to re-enter at a favorable price.
Instead of using momentum oscillators like Stochastics, day traders often prefer to use the Parabolic SAR in shorter time frames to enter and exit trades. An example would be establishing a trend on the 5 minute chart and using Parabolic SAR on the 1 minute chart to enter and exit trades.