The Parabolic Stop and Reverse (SAR), is a trend following indicator that uses colored dots to visually signal current price direction.
It can also use the dotted lines to highlight entry and exit signals.
It's actually quite simple. When the Parabolic SAR plots dots below the price, it's a signal that price movement is on an uprtrend. Conversely, if dotts are plotted above the current market, then price movement is on a downtrend.
To be clear, you never want to rely on just one indicator solely. Make sure to verify your findings with other indicators, including Bollinger Bands (2,20), MACD, RSI and Williams’ %R. Look for confirmation.
We can see the Parabolic SAR in action with Weight Watchers (WTW).
On this one-year chart of tWTW, we can clearly see the dotted lines. When they are above the price of WTW, the stock has a tendency to move lower. Then, when they’re below the price of the stock, it begins to pivot higher.
It should be noted that the Parabolic SAR typically appears at the upper Bollinger Band (2,20), as RSI, MACD and Williams’ %R range begin to pivot in the opposite direction. Almost 80% of the time, when all of these indicators are in alignment, the stock pivots in the other direction.
We can see this in the Dow Jones Industrial Average ($INDU), too.
In fact, using the Dow Jones, we can see SAR is by no means a perfect indicator. In August 2018, even with SAR above the price of the Dow, the index continued to push higher.
This is simply another reason why it’s essential to confirm your findings using other indicators at all times.
The other downside is that the Parabolic SAR does not provide much insight or signal during sideways trending assets and markets. With no trend, you’ll see the SAR flip-flop back and forth without any clear indication of direction.