This is an indicator which is used to establish the direction of price movement and pinpoint the time when the momentum of the movement has a reasonably high chance of changing direction. The SAR stands for “stop and reverse” and is indicated by dots placed above or below the price shown on the chart. Signals can be generated from the placement of the dots and a dot below the price is a bullish signal indicating that the momentum is going to continue upwards. Similarly, a dot above the price is a bearish signal suggesting that the momentum is going to continue downwards.
The first entry signal for buying when the upward price trend has been broken and the first SAR can be placed at the most recent low. As the price continues to move upward, the dots will also move in the same direction accelerating as the move gains momentum. The acceleration enables the trader to spot trends in the develop and then establish themselves. The indicator works best when prices are trending because false signals can be generated if the price is ranging or volatility is unusually high.
The indicator is particularly useful in determining the positions of stop losses. It can also help traders to lock in on profits that have already accrued on paper in trending markets. Traders who have established short positions use this indicator to establish the timing for covering their short position. It is mechanical because the underlying assumption is that the trader will always have a long or short position. This allows for the elimination of all emotion from trading judgment and encourages the trader to trade in a disciplined manner.
Traders will normally use several indicators before taking a position and the signals from the SAR will be checked against other indicators such as stochastics, candlesticks and moving averages. For instance, the price reversal indicated by the dots moving from below the price to above the price is more credible if the price is above the moving average.
The Stochastic Oscillator is an indicator of momentum which shows the position of the closing compared to the highs and lows over a given number of periods. It does not concern itself with fa. ctors such as volumes and price and restricts itself to the speed or the momentum of changes in price. As a result, the oscillator can be used to employ bullish and bearish divergence in forecasting price reversals. Because it is range bound, traders often use it to signal overbought and oversold market levels. The default setting for the oscillator is a timeframe of fourteen periods which can be days, weeks or even months. It uses the most recent closing, the highest high and the lowest low for the fourteen periods.
If the highest high is 120, the close is 110 and the lowest low is 100, the difference between the high and the low of 20 becomes the denominator in the calculation. The difference between the close and the low of 10 becomes the numerator and the result of the calculation is 0.50. The result multiplied by 100 gives us 80 and a close in the upper half of the range will produce a result of more than 50 and a close in the lower half will produce less than 50. Readings of below 20 would indicate that the price is near it’s low for the selected time frame and conversely readings of over 80 would indicate that the price is near its high.
Because the indicator is restricted to a range of 0 to 100, it is useful in identifying overbought and oversold levels. It does not matter how rapidly the price advances or declines, the fluctuations will continue to be in this range. Normal settings use 80 as the overbought threshold and 20 as the oversold threshold. It is important to understand that overbought conditions need not necessarily equate a bearish market because these conditions can happen even in a market trending upward. Closing prices which are consistently near the top end of the range indicated sustained buying interest. Similarly oversold conditions do not necessarily mean a bullish market and closing prices near the bottom end of the range nearly indicate sustained selling interest.
Divergences arise when new highs or lows in prices are not confirmed by the stochastic oscillator. A bullish divergence arises when the price hits a lower low but the oscillator shows a higher low. This would indicate less downside momentum which could mean that a bullish reversal is possible. Similarly, a bearish divergence could happen when prices touch a higher high but the oscillator shows a lower high. This could indicate lowered upside moment which could result in a bearish reversal. Before you act on these divergences, you should seek confirmation. Bearish divergences can be confirmed if there is a break in support levels and bullish ones by a break in resistance levels. This is why 50 is probably the most important level to watch.