Today we are going to discuss the indicator called PSAR. The PSAR or Parabolic Stop-and-reversal indicator is a technical strategy that uses trailing stops and reversal methods. This indicator is used to help determine areas where traders can enter and exit positions. This method was developed by J. Wells Wilder who also developed the RSI indicator and is a simple way to identify entry points. If the price is above the PSAR you would want to be long and if the price is below the PSAR you would want to be short. Entry and exits occur as the PSAR changes from above to below the price or from below to above the price. This indicator is a bit unique in that it does not use lines but rather a series of arrows or dots to indicate when the momentum is moving up or down. In the chart below you can see the PSAR as shown on an hourly chart of the EURUSD.
Notice that when the price moves down that the dots move above the price indicating a shorting opportunity and when the dot moves below the price it is buying opportunity. This is a simple way to know if the momentum is beginning to move down or move up. As the PSAR changes one would look to enter the trade to take advantage of this momentum shift or reversal. Because this work well when the market is trending you would want to be careful in a sideways market where the indicator seems to produce more choppy signals and whip saw in price.
In order to avoid this you could consider adding a trending type of indicator such as a Simple Moving Average. If you place something like a 40 period Simple Moving Average you would look to only take trades in the direction of this trend. Take a look at the chart below to see how adding this SMA to the PSAR can help in eliminating some of the choppiness.
When the 40 SMA is going down you would skip taking the long trades as the PSAR dots move below the price. By avoiding these counter trend entries you will miss taking some of the unprofitable trades.
This indicator is a popular was to look for entering and exiting trades. Remember that there is no perfect indicator and that nothing works all the time but using a simple indicator like this can help clarify when entries may be happening. Also, this indicator can be used on any time frame and can help to identify where you may place your initial and trailing stops. Once you enter into the trade you would place your stop loss above or below the new dot. Take a look at the chart below to illustrate what this might look like.
Once you enter into a long position as shown above you would place your stop below the new dot. You could also adjust your stop below the next dots as they begin to move higher. Your exit might occur when you get you reversal dot to short.
Take some time to practice with this to make sure you can see how this indicator works.