Up until now, we’ve looked at indicators that mainly focus on catching the beginning of new trends. Although it is important to be able to identify new trends, it is equally important to be able to identify where a trend ends. After all, what good is a well-timed entry without a well-timed exit?
One indicator that can help us determine where a trend might be ending is the Parabolic SAR (Stop And Reversal). A Parabolic SAR places dots, or points, on a chart that indicate potential reversals in price movement.
From the image above, you can see that the dots shift from being below the candles during the uptrend to above the candles when the trend reverses into a downtrend.
How to Trade Using Parabolic SAR
The nice thing about the Parabolic SAR is that it is really simple to use. We mean REALLY simple.
Basically, when the dots are below the candles, it is a buy signal.
When the dots are above the candles, it is a sell signal.
Yes, we thought so.
This is probably the easiest indicator to interpret because it assumes that the price is either going up or down. With that said, this tool is best used in markets that are trending, and that have long rallies and downturns.
You DON’T want to use this tool in a choppy market where the price movement is sideways.
Using Parabolic SAR to exit trades
You can also use Parabolic SAR to help you determine whether you should close your trade or not.
Check out how the Parabolic SAR worked as an exit signal in EUR/USD’s daily chart above.
When EUR/USD started sliding down in late April, it seemed like it would just keep droppin’ like it’s hot. A trader who was able to short this pair has probably wondered how low it can go.
In early June, three dots formed at the bottom of the price, suggesting that the downtrend was over and that it was time to exit those shorts.
If you stubbornly decided to hold on to that trade thinking that EUR/USD would resume its drop, you would’ve probably erased all those winnings since the pair eventually climbed back near 1.3500.