The Complete Guide to Supertrend Indicator Trading
The supertrend indicator is one of the most popular trading indicators used by thousands of traders globally. This comprehensive guide will teach you everything you need to know about the supertrend indicator and how to effectively use it in your own trading.
What is the Supertrend Indicator?
The supertrend indicator is a custom technical indicator that helps traders identify the current market trend. It was created in the 1990s by Olivier Seban, a technical analyst.
The supertrend indicator is constructed with two parameters – the Average True Range (ATR) and a multiplication factor. The ATR tracks short-term volatility while the multiplication factor allows you to adjust the sensitivity of the indicator.
Once calculated, the supertrend indicator plots a line above or below the price bars. This line acts as the indicator’s main signal line, similar to a moving average. When price is above the line, the indicator is bullish. When price is below the line, the indicator is bearish.
The supertrend indicator aims to identify ideal entries and exits based on the current market trend. Its main advantages are its simplicity, customization, and effectiveness for trend trading strategies.
How Does the Supertrend Indicator Work?
The supertrend indicator is calculated using the following formula:
Supertrend Line = (HIGH + LOW) / 2 + Multiplier * ATR
Where:
- HIGH – the highest price of the current period
- LOW – the lowest price of the current period
- ATR – the Average True Range
- Multiplier – the sensitivity adjustment factor
The supertrend line acts as a trailing stop. As price fluctuates, the line moves up or down according to the formula.
When the price closes above the supertrend line, the line moves up to follow price. This creates a new support level and bullish signal.
When the price closes below the line, the line moves down with price. A new resistance level forms and a bearish signal is given.
This dynamic upper and lower band helps traders clearly identify the prevailing trend. It also gives objective entry and exit levels based on recent volatility.
The Key Benefits of Using the Supertrend Indicator
There are several advantages gained by incorporating the supertrend indicator into your trading:
- Trend identification – The supertrend indicator excels at visually defining the current trend direction. The line acts as a moving support/resistance level that adapts to price.
- Trading signals – Crossovers of the supertrend line generate clear trading signals. A bullish crossover signals ups ide momentum is accelerating. A bearish crossover signals downside momentum is accelerating.
- Customization – The multiplier input allows you to adjust the indicator’s sensitivity based on your strategy. A higher multiplier equals a less sensitive indicator good for long term trends. A lower multiplier equals a more sensitive indicator for short term trades.
- Volatility filter – By incorporating the ATR volatility measure in its formula, the supertrend indicator adapts to changing market conditions. During volatile markets, the bands widen to filter out false signals.
- Stop loss tool – The supertrend line acts as a trailing stop level. Traders often use the crossover points as places to trail stops, protecting profits in winning trades.
For trend traders, the supertrend offers an efficient way to gauge trend direction, enter at optimal levels, and manage trades.
Supertrend vs. Moving Averages
The supertrend indicator differs from traditional trend indicators like moving averages in two major ways:
1. Dynamic levels – The supertrend line adapts to price action as new highs and lows form. Moving averages lag price and must catch up to changes in trend.
2. Volatility filter – The ATR component helps filter out false signals during volatile conditions. Moving averages do not account for volatility.
These advantages make the supertrend more responsive and accurate in choppy or ranging markets. It stays with the trend better, avoiding whipsaws.
However, in strongly trending markets, simple moving averages often signal turns earlier than the supertrend line. Traders will often combine both indicators to improve timing and confirm trade signals.
How to Use the Supertrend Indicator in Your Trading
Now that you understand what the supertrend indicator is and how it works, let’s discuss ways to effectively utilize it in your own trading system.
Here are a few commonly used strategies:
- Trend filter – Use the supertrend line to determine the biases of other indicators. For example, only take buy signals from an oscillator when supertrend is bullish. Ignore sells when supertrend is bearish.
- Momentum trading – Look for the price to break the supertrend line by a significant amount. Enter trades in the direction of the breakout as momentum accelerates.
- Breakout trading – Trade false breakouts that fail to hold. If price closes back below the supertrend line after a bullish crossover, sell the rally. If price closes back above after a bearish crossover, buy the dip.
- Range trading – Enter counter trend inside the supertrend bands. For example, buy near the lower band in an uptrend for mean reversion. Sell near the upper band in a downtrend.
- Exiting trades – Trail stops under long positions when the supertrend line turns bearish. Trail stops above short positions when the line turns bullish.
Make sure to backtest to find the best supertrend settings and rules that fit your trading style. Small tweaks can often significantly improve performance.
Supertrend Indicator Settings
The most important setting on the supertrend indicator is the multiplier factor. This controls the sensitivity.
Some general rules for setting the multiplier are:
- Day trading – Use a multiplier between 2-5 for more sensitivity to price changes. Lower multipliers work best for active markets with lots of noise.
- Swing trading – A multiplier between 5-10 is good for swing trading trends over hours or days. This smoothes out minor fluctuations.
- Position trading – For long term trends over weeks and months, set the multiplier between 10-20. This focuses only on the broad trend.
The Average True Range period can also be adjusted, with shorter periods being more responsive but less stable. The most common ATR periods used are 10 and 14 bars.
Every market and time frame will be a bit different. The best practice is to run backtests to optimize your supertrend settings.
Supertrend Trading Tips
Here are some useful tips to improve your supertrend trading performance:
- Use the indicator mainly as a way to define the trend. Let price action confirmation and other indicators determine your actual entries and exits.
- Be wary of signals that form too close to the supertrend line. The more distance between the crossover and the line, the higher probability the trade.
- Trail stops along with the supertrend line once in a trade. Move your stop in the direction of the exiting crossover.
- Filter trades taken counter to the main supertrend trend. These have lower probability, so increase your criteria for a valid setup.
- Combine the supertrend with oscillators that measure momentum. Divergences with the supertrend often signal profitable turn points.
- Use a shorter time frame supertrend to manage trades and pinpoint entries on a longer time frame.
Mastering the nuances of the supertrend indicator will greatly improve your ability to ride large, profitable trends. But remember – always use prudent risk management on all your trades.
Supertrend Indicator vs. Other Indicators
The supertrend indicator belongs to the category of trend following indicators. Some other popular indicators in this group include:
Moving Averages – The backbone of trend trading, moving averages smooth out price action to see the direction. They lag price though and whipsaw during consolidation.
Parabolic SAR – Similar to supertrend, Parabolic SAR places dynamic dots above or below price to determine trend. Works well for fading counter trend moves.
Ichimoku Cloud – The Ichimoku cloud lines provide support and resistance for the trend. Also gives bull/bear signals with color of cloud.
Average Directional Index (ADX) – The ADX specifically measures trend strength on a scale of 1-100.Values above 25 indicate a strong trend is present.
Bollinger Bands – Bollinger bands create a volatility based envelope above and below price. The squeeze signals impending breakouts.
Each indicator has strengths and weaknesses. Combining the supertrend with other complementary indicators provides more robust signals and confirms trade triggers.
Common Supertrend Trading Mistakes
While the supertrend indicator offers reliable trend signals, traders still make mistakes improperly using it. Here are some key errors to avoid:
- Chasing crosses too late – By the time of the crossover, a large portion of the move has occurred. Look to enter on the breakout or first pullback instead.
- Not accounting for spread – In forex and futures trading, the bid/ask spread may cause false crosses. Give the crossings room to confirm.
- Ignoring additional confirmation – Blindly taking every crossover signal will lead to numerous failed trades. Wait for candlestick or momentum confirmation.
- Not optimizing settings – Failure to backtest and find the ideal settings for your timeframe undermines the strategy.
- Forgetting stop loss – Neglecting proper risk management makesaccount devastating losses possible on failed trades.
- Overtrading – Over leveraging and taking too many trades will cause commissions and slippage to eat away at profits over time.
With proper usage, the supertrend indicator can achieve win rates above 65%. Refine your skills by studying examples of good and bad trading.
Supertrend Indicator Examples
To see the supertrend indicator in action, let’s look at a few real chart examples:
Strong trend – During strong trends with long sustained moves, the supertrend line stays with price action. Minor counter trend moves are ignored by the indicator. Riding the directional crosses produces large gains.
Choppy market – When the market is choppy and ranging, whipsaws are avoided because the supertrend line acts as a volatility filter. Trades should be taken selectively only in the direction of the broader trend.
Sharp reversal – On sharp reversals, the supertrend line lags price and creates late exit signals. Traders can improve exits by using candle patterns or momentum oscillators for additional confirmation.
False breakout – Failed breakouts occur when price breaks the supertrend line but quickly reverses back. These false signals can be traded by fading the fakeout back to the supertrend line.
Analyzing example charts trains your eye to properly interpret what the supertrend indicator is signaling. Each market environment provides learning opportunities.
Frequently Asked Supertrend Questions
Here are answers to some frequently asked questions about the supertrend indicator:
What is the best supertrend multiplier setting?
The best multiplier depends greatly on the particular market and time frame. Backtesting can determine the optimal setting. As a starting point, try a multiplier between 3-5 on short term charts and 7-15 for longer term charts.
Does supertrend work for scalping?
Yes, the supertrend can be effectively used for scalping strategies on the 1 minute and 5 minute timeframes. Use a very low multiplier around 1-3 for maximum sensitivity. Confirm crossovers with candle patterns or momentum oscillators.
What time frame is best for trading with supertrend?
The supertrend indicator works on all time frames. Scalpers use the 1 or 5 minute charts. Day traders favor the 15 minute and hourly charts. Position traders prefer the 4 hour, daily and weekly time frames. Choose based on your trading style.
How do you use ADX with supertrend?
Adding an ADX indicator shows if the trend is strong enough to trade. Buy supertrend signals only when the ADX line is above 25 and sell signals when it is below 25. The ADX acts as a filter for less reliable counter trend trades.
Does supertrend repaint?
No, the supertrend indicator does not repaint. Once plotted, the line will not shift backward. The indicator only updates when a new period forms. Valid signals can be traded at the open of the next bar.
Should I trade every supertrend signal?
No, blindly trading every crossover will lead to many failed trades. Use the supertrend mainly to define the overall trend. Then look for candlestick confirmation and momentum divergences to increase the quality of trade signals.
The supertrend indicator certainly has limitations like all indicators. With backtesting and practice, traders can learn to integrate it into profitable trend following strategies.
Conclusion
The supertrend indicator deserves its popularity among active traders. By summarizing the trend and volatility into one line, it spotlights high probability trade setups.
Consistent profits require combining the supertrend with prudent risk management plus other confluence factors. But as part of a robust trading plan, this standout indicator will serve trend traders very well.
This comprehensive guide teaches you everything you need to know to gain an edge using the supertrend indicator. Now it’s time to start practicing trading with it consistently. As with any skill, experience over time will lead to mastery.
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