So far, we’ve looked at technical indicators that are primarily concerned with detecting the start of new trends.
It is critical to be able to identify new trends, but it is also critical to be able to discern where a trend stops.
After all, what good is a well-timed entry if you don’t exit on time?
One indicator that can help us determine where a trend might be ending is the Parabolic SAR (Stop And Reversal).
A Parabolic SAR places dots, or points, on a chart that indicates potential reversals in price movement.
From the image above, you can see that the dots shift from being below the candles during the uptrend to above the candles when the trend reverses into a downtrend.
How to Trade Using Parabolic SAR
The Parabolic SAR has the advantage of being quite simple to operate. We mean REALLY easy.
When the dots are below the candles, it indicates a BUY signal.
It is a SELL signal when the dots are above the candles.
Yes, we thought so, too.
This is arguably the simplest indicator to understand because it assumes that the price is either rising or falling. That being said, this method works best in markets that are trending and have long rallies and downturns.
This tool should NOT be used in a turbulent market with sideways price movement.
How to use Parabolic SAR to exit trades
You can also utilize Parabolic SAR to help you decide whether or not to close your deal.
See how the Parabolic SAR functioned as an exit signal in the EUR/USD daily chart below.
When the EUR/USD began to fall in late April, it appeared like it would continue to fall like a rock.
A trader who was able to short this pair may have wondered how low it could fall.
In early June, three dots formed at the price’s bottom, indicating that the downtrend had ended and it was time to exit those shorts.
If you had stubbornly opted to continue on to that trade, believing that the EUR/USD would resume its decline, you would have most likely lost all of your profits because the pair eventually rebounded back near 1.3500.
Next Lesson: How to Use the Stochastic Indicator