How to Combine Parabolic SAR with Bollinger Bands - ForeXposed


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Friday, September 22, 2017

How to Combine Parabolic SAR with Bollinger Bands

Parabolic SAR

In 1978, in the book “New Concepts in Technical Trading”, J. Welles Wilder introduced the Parabolic SAR (commonly abbreviated as SAR), along with Relative Strength Index (RSI) as one of the main indicators in trading. SAR is short for Stop And Reverse, which more or less defined as the Stop Loss determining point indicator in forex trading.

In the process, Parabolic SAR becomes one of the effective indicators in determining the market conditions when trending along with the facilities named Trailing Distance, which many forex brokers provided it in the various forex trading platform.
How to Combine Parabolic SAR with Bollinger Bands

How to Use Parabolic SAR

Parabolic SAR uses exactly the same with Moving Average (MA) or other trend indicators. Wilder creating this indicator to eliminate the lack of MA, i.e. its curve form, that make misinterpretation happens. With the SAR in the form of dots, The trend up or down looks more certain and no longer give misinterpretation.

In the SAR, as prices are in the trend up, then the SAR points is below the price movement. Conversely, when the market was in a downtrend then the SAR point is above the price movement. Consider the following image:

In the picture above, the SAR point is above the bar which shows that the price trend was down.

Now let's look at the picture below:
How to Combine Parabolic SAR with Bollinger Bands

As already explained above, the excess of Parabolic SAR is how it looks in the form of dots, making it easier for a forex trader in reading the market conditions. Traders simply need to see where the SAR dots position, whether under or above the bar to know the ongoing trend.

More than that, the farther the distance between the SAR dots with the highest price points or the lowest price points of the bar, it indicates the increasing trend power, goes up or down.

Once you know how to read the Parabolic SAR, it will become easier to use it to perform an action on buy, sell, or hold. Need to be presented here, that it is very recommended to use SAR along with other indicators. (I personally recommend adding the Stochastic Oscillator or Relative Strength Index).

This indicator is like other trend indicators which often slow in accommodating the price changes. Likewise with the SAR. That is why it is recommended to add an oscillator which tends to be faster, so the two can be mutually offsetting. SAR can reduce the speed of Oscillator, whereas Oscillator can be valid otherwise.

Let us look at the picture below: 
How to Combine Parabolic SAR with Bollinger Bands

In the area that I've circled with purple is the confirmation that both indicators show the same direction. Stochastic giving signal that the price trend was an uptrend and the SAR dots is also on the bottom which shows the price is moving up. Buy action can be done in these circumstances.

The second purple circle on the right also showed the same case, but better results, because apparently the SAR dots and Stochastic indicate the uptrend conditions, but in a state where the uptrend has just begun. Thus, the profits can be much larger than the first purple circle.

Simple isn't it? You can integrate SAR with other indicators such as MACD or RSI indicator, depending on which is the best and suitable with your daily trading style. Please keep in mind, every trader has his favorite indicators respectively.

Parabolic SAR and Stop Loss

Now we enter into a discussion about the unique use of the SAR. Even just the SAR has the ability like this, i.e. the use of SAR as the determining point of Stop Loss. Remember, that the SAR is short for Stop and Reverse.

The point of the SAR not only can be used as a decisive for uptrend or downtrend. Similarly, the distance between the point of the SAR at the lowest price or the highest price of the bar not only can be used as strong or weak determinants  for the ongoing trend. More than that, if you are a forex trader with Stop Loss (strongly recommended to trade using the Stop Loss), then the good news is you can use the SAR points as Your Stop Loss points.

Some newcomers in forex world are very hated to the facilities called Stop-Loss. The reason is, if they put up a Stop Loss, then often their positions touching the Stop points, which means it is a loss for them. Finally, they opted to let the floating prices with pending the night ends and the morning shines, aka the price reverses direction so that their negative positions changed with the positive.

The bad news for those who trade in this way, the time will come where maybe the night would never end, and the morning never came, aka margin call happens. It's not just one or two times, but most of those who trade without a stop loss always lead to the same fates. Something that I already explain thousands of times to any novice investor, who amazingly are very rarely observed.

Remember, Stop-Loss is not to make you lose your money. It is to limit your losses and distancing yourself from the nightmare called margin call. Of course, you don't want to trade only one or two times and then smashed and destroyed just because of one position. None trader never wrong in determining position. Didn't matter how many times you were wrong in determining position, what matters is in the aggregate, you can keep the profit!
Now let's get back on the discussion about SAR and Stop Loss. 

Look at the image below: 
How to Combine Parabolic SAR with Bollinger Bands

In the picture demonstrated above when the SAR point moves from the top towards the bottom, then it is an indication that the downtrend has been completed and continued with the uptrend. In these conditions, then it is time to do the Buy action. However, as we understand that we cannot ensure 100% that the prices will constantly rise. Thus, we need to use limit Stop Loss (SL) in the open position. We can use the lowest point of the SAR as a benchmark.

You can also combine the SAR facilities with trailing distance, on the platform. Different to Stop Loss that are static and cannot be shifted automatically, a trailing Stop-Loss is a dynamic or can move following the price movements.

For example in the image above, if you open a Buy position on 1.9635, that means there are distance 44 points from the Stop start points (1.9635 - 1.9591). That means you can specify that the distance of Stop shouldn't be more than 44 points if you are using a Trailing Distance as your Stop. If the price moves up to 1.9700, then automatically your Stop Loss will be shifted to 1.9656, aka keep a 44 point if you use the Stop Loss with Trailing Distance models.

Most of the forex trading platform provides a trailing facility for customers. If you are a SAR user, you may need to use this facility.

Basically, the opening position and add trailing stop points is one of a very good step in defining the policies of our profit. With a trailing stop, you no longer need to add the Limit as a limitation of your benefit. Trailing can be useful as a Stop Loss and also limit. The image below is the trail facilities on the platform: 
How to Combine Parabolic SAR with Bollinger Bands

The Restrictions on the Parabolic SAR

We have been studying the various aspects of this indicator. SAR is very effective used in various trending market conditions. But there are moments in which SAR is ineffective and cannot be used as the main indicator.

When is it?

Precisely when the market is moving sideways, or in a situation of no trend for price movement. The condition is characterized by the close distance between the SAR points and the highest/lowest price. Sideways is worse condition marked by the move around of point of the SAR, above and below the bar. So make us difficult to open a position. That is why, from the beginning, I recommend using SAR along with other indicators, as a cover shortages of the SAR.

Consider the following image: 
How to Combine Parabolic SAR with Bollinger Bands

If you are using trend indicators with curve shaped like Moving Averages (MA), then it would appear that MA twisted each other move between two different periods. So also with the Stochastic.

This sideways situation usually happens when the market is closed, or the market participants were waiting for an important news that will soon be released. Opening position indeed advisable to not do at the time of sideways. Unless you're willing to wait long enough and has a strong enough mentality to see the floating price.

Well here about Parabolic SAR. Now we will study other indicators named Bollinger Bands.

Bollinger Bands

Created by John Bollinger in the early 1980 's to help compare volatility and prices relativity in a period of analysis. Originally, the Bollinger Bands consist of three lines that form a sort of border belt against the price movement. However, in its application, the middle line of the Bollinger Bands is often not shown, because indeed the midline line is just Moving Averages. Consider the following image:
How to Combine Parabolic SAR with Bollinger Bands
Source: BelajarForex
As already explained above, the shape of Bollinger Bands resembles the belt which is limiting the price movement. Are you find something from the picture above? Yes, if there is an imbalance between the demand and supply, then the Bollinger Bands will be more widened than the balanced conditions.

On the above image, the chart is displaying the GBPUSD 1H period on May 2, 2007. As shown above, when the price is increasing then the belt is inflated more width compared to the state when there are no trend trends, or the trend is not strong enough. Even at any given moment, the belt becomes so narrowed. These circumstances will indicate two possibilities. The first is the transactions were completely deserted, or the majority of market participants are waiting for a news release to do next buy or sell actions.

As a volatility indicator, actual Bollinger Bands can’t stand on its own. This indicator is usually used only as a preliminary indicator to measure the price relativity and volatility. Bollinger Bands is not an action indicator, so it is recommended, if you are using this indicator, also use other indicators before making a decision to buy or sell.

How to Use Bollinger Bands with RSI

Each indicator has certain characters. One thing unique owned Bollinger Bands is making every forex trader able to interpret these indicators with their respective way. Although there is some fixed rule in the Bollinger Bands, but it could have been different ways and different usage in using Bollinger Bands by one trader with another. The following is a general character applicable to the Bollinger Bands: 

  • Bollinger Bands is a beginning indicator that cannot be used as an action indicator. Should be used along with other indicators. Specify one of the best indicators for you as an action indicator, however, do not use more than one action indicators. Some indicators that good action indicator is RSI, Stochastic or momentum.
  • In general, the prices will move in the belt, however, the price can also move outside the belt. This can be mean that the reversal will occur, or the opposite, there was an ongoing trend strengthening. To find out, we can see the action indicator that we use.
  • The determination of the period in the Bollinger Bands also takes effect. The smaller the period used then the width of the belt will be getting smaller and vice versa.

If we mix Bollinger Bands with RSI, this is the result:

  • If the price is outside the upper band or parallels with the upper band, while the RSI is still below the overbought zone, this means a continuation of the trend will occur. Conversely, when the RSI is already in the overbought area and leaving the overbought area, this means a trend reversal will occur on the next candle.
  • If the price is outside the lower band or parallels with the lower band while the RSI is still below the oversold zone, this means a continuation of the trend will occur. Conversely, when the RSI is already in the oversold area and leaving the oversold area, this means a trend reversal will occur in the next candle.

Well, let's look at the following picture: 
How to Combine Parabolic SAR with Bollinger Bands
Image: BelajarForex
Notice the circled area and the size of smoothing RSI. At 1.1932, the size of smoothing RSI is 39.9429, and the price has penetrated the upper band twice. This indicates that the trend continuations will occur. In the price increases, noted that the price broke through the upper band several times, but the RSI has not left the overbought area. This means the trend will still continue until the RSI leaves the overbought area.

Now compare with the picture below: 
How to Combine Parabolic SAR with Bollinger Bands
Source: Belajar Forex
In the area that I've circled, the smoothing RSI value is 31.7379, and the price has penetrated the lower band with bullish candle three times. Thus, can be predicted that the trend reversal will occur as shown in the next candle. Why can I give you an estimate that the trend reversal will occur, from bearish toward bullish? That's because my action indicator indicates the prices have left the oversold area and leads towards the overbought area.

It can be concluded from the example above, that we can combine Bollinger Bands with other indicators when we understand the use of these other indicators correctly. The use of appropriate indicators will produce a decision that more accurate. The more we understand the use of action indicators the bigger chance we can make use of Bollinger Bands as a volatility indicator.