Parabolic Indicator (SAR)

The Parabolic System, devised by Welles Wilder, is not a momentum indicator, and so strictly speaking. However, it is very popular trading mechanism and can be used to generate timely stop-loss signals.

One of the most valid criticisms of trend-following systems is that the implied lags between the turning points and the trend-reversal signals obliterate a significant amount of the potential profitability of a trade.

The Parabolic System is designed to address this problem by increasing the speed of the trend, so far as stops are concerned, whenever prices reach new profitable levels. The concept draws on the idea that time is an enemy, and unless a trade or investment can continue to generate more profits over time, it should be liquidated.

Since it is a stop-loss system, it can be used with any momentum series, once that indicator has been used to filter out a good entry point for a trade. It is also a trailing stop-loss system, which means that the stop is continually being moved in the direction of the position, that is, up for a long position and down for a short one.

When the position is first initiated, it is given a relatively long leash, so to speak. Then, as time passes, and the price increases, the stop is gradually tightened. The expression parabolic arises from the shape of the curve of the stops as it appears on the chart. In a rising market, the stop is continually being raised, never lowered. In a declining market, the opposite will hold true.