Why Parabolic SAR Was Created

The Parabolic SAR (Stop and Reverse) was created by J. Welles Wilder Jr. in 1978 to help traders identify potential trend reversals and maintain momentum-based exit points. Unlike many indicators that focus on overbought/oversold conditions, the Parabolic SAR was designed specifically for trending markets, emphasizing when a trend might be losing momentum.

Wilder developed the indicator to address the challenge of staying in profitable trends while avoiding large losses during reversals. Traditional methods often caused traders to exit too early or too late, leading to missed opportunities or significant drawdowns. The SAR provides dynamic support and resistance levels that adjust based on price action.

The indicator works by plotting a series of dots above or below the price chart. When dots are below the price, it signals an uptrend; when above, it indicates a downtrend. As the price moves, the dots follow, accelerating as the trend extends. A reversal occurs when the dots flip from one side of the price to the other.

This mechanical approach removes emotional decision-making from trade exits and entries. Wilder intended for traders to use SAR as part of a broader strategy, often combining it with his other tools like the ADX to confirm trend strength. By focusing on momentum decay rather than price levels alone, the Parabolic SAR fills a unique niche in technical analysis.

It's especially effective in strongly trending markets but can produce false signals in choppy or sideways conditions. Understanding its origins helps traders appreciate the indicator's role in trend-following strategies rather than expecting it to function as a standalone solution.