An effective use of the Parabolic SAR is determining where to place stop loss orders to protect profits or minimize losses. The chart below of Gold illustrates stop loss placement using the Parabolic SAR indicator:
The Parabolic SAR is an effective stop loss placement tool for two reasons:
- It acts as a trailing stop. Rather than putting in one stop loss below where a trader entered a long position or above where the trader entered a short position, using the Parabolic SAR as a trader's guide, the stop loss is gradually raised for a long position and lowered in a short position, effectively locking in any profits.
- It acts as a time stop. Time stops are used by traders because they enter in buy or sell orders expecting a certain move to occur. If the expected move never occurs and the reason the trader initiated the trade is no longer relavent, then the trader should exit their trade. Similarly, the Parabolic SAR incorporates time into its calculation making sure a stock, future, or currency trade is working for the trader, if the trade is not moving in the desired direction, the Parabolic SAR will signal an exit.
In yet another effective technical indicator created by Welles Wilder and chronicled in his classic New Concepts in Technical Trading Systems, the Parabolic SAR gives easy to interpret buy and sell signals as well as creates an easy to follow methodology for entering stop loss orders.
