What Parabolic SAR Really Measures

The Parabolic SAR (Stop and Reverse) is a trend-following indicator that measures the potential reversal points of price action by plotting dots either above or below the price chart. It was developed by J. Welles Wilder Jr. and is primarily used to identify the direction of a trend and signal possible exit points when the trend shows signs of reversing.

The core function of the Parabolic SAR is to track momentum and acceleration of price movement over time. It does this by calculating trailing stop levels based on a mathematical formula that incorporates the asset's recent highs and lows, along with a component called the Acceleration Factor (AF). As price moves in one direction, the SAR dots gradually get closer to the price, reflecting increasing momentum.

When the price penetrates these SAR levels, it suggests that momentum may be weakening and a trend reversal could be imminent. The indicator measures not just trend direction, but also the exhaustion points within that trend. This makes it particularly valuable for traders looking to time their exits rather than predict new entries.

In trending markets, the Parabolic SAR tracks the price closely, staying beneath it during uptrends and above during downtrends. The distance between the dots and the price reflects the strength and pace of the trend: tighter spacing implies stronger momentum, while wider spacing may suggest weakening movement.

It is crucial to understand that the Parabolic SAR does not predict reversals but reacts to them. It measures the evolving relationship between price momentum and potential turning points by dynamically adjusting its levels. This lagging nature makes it most effective in strong, sustained trends rather than choppy or sideways market conditions.