The Parobolic sar is a method of technical analysis, devised by J. Welles Wilder Jr., in order to identify trends in the markets. The concept behind the parobolic sar is that time is not on your side, and if a security or market cannot generate more profits over a period of time, it ought to be liquidated. This indicator works very well with markets that are trending. A parabola that is below the price generally indicates a bullish or upward trend, while a parabola that is above the price indicates a bearish or downward trend.
An example of a Parobolic Sar Chart:
Interestingly, the SAR is calculated for a future time period for each step in a trend. Tomorrow's SAR calculation is equated by using data that is available today. The formula for calculating the Sar is:
n and n+1 reflect today's Sar values and tomorrow's values, respectively.
The EP or extreme point is kept during each trend; it represents the highest value that is reached during an uptrend, or the lowest value reached during a downtrend. The EP gets updated when new highs or lows are observed.
The α is the acceleration value. Normally, this is set to .02, and is increased by .02 each time a new EP is observed. This will accelerate the rate at which the SAR moves towards the price. A maximum amount is generally set for 0.20, to keep it from getting too big.
The SAR will continue to be calculated in this manner; however, there are some special cases that could modify the SAR value:
If tomorrow's SAR is within or above yesterday or today's price range, the SAR is set to the closest price.
If tomorrow's SAR is within or above tomorrow's price range, then a new trend direction is identified; the SAR then switches sides.
In the case of #2, the first SAR for the new trend is set to reflect the last EP that was recorded on the previous trend. This EP is reset to this period's maximum, and the acceleration factor will be reset to the original value of 0.02.