From The Free Forex Encyclopedia
The parabolic SAR (short for Stop And Reverse) is a very complicated predictive algorithm designed to establish a trailing stop-loss level for asset markets that follow strong bullish or bearish trends. The algorithm was introduced by J. Welles Wilder, Jr. in his 1978 book, “New Concepts In Technical Training Systems.”
The parabolic SAR for any given day is calculated before that day's trading, incorporating the extreme high or low value of an asset from the previous day as well as a variable acceleration factor designed to make emerging trends more visible to the trader. A parabolic SAR graph takes the form of a series of points—ideally arranged in a parabola—either above or below the price line. When the SAR points cross below the price line, long positions should be closed; when the SAR points cross above the price line, short positions should be closed. Since the SAR point for a day is calculated in advance, this graph allows traders to set their stop-loss levels at the beginning of the day in order to capitalize immediately on probable trend reversals. This creates a stop-loss level highly responsive to large-scale shifts.
The parabolic SAR is effective only for markets with strong trends, which, according to Wilder, comprise only 30% of markets. In horizontal markets, or markets dominated by rapid yet irregular fluctuations, the SAR becomes much less accurate at finding useful stop-loss levels, and other predictive tools should be used.