- February 16, 2023
- Posted by: CoachShane
- Category: Trading Article
For Stocks and Options traders looking to maximize their profits, learning how to use the Supertrend Indicator can be helpful. This technical indicator can help you determine the state of the trend which can make your trading easier.
Whether you swing trade or day trade, here are a few benefits of using the Supertrend Indicator:
• Easily identify trend direction so you can trade with the trend
• Buy and sell signals presented depending on the trading system you are using
• Increase odds of winning trades when combined with price action and other variables
• Objectively determine the trend of the market
No matter what type of trader you are, understanding how to use the Supertrend Indicator can help you maximize your profits, find more accurate setups, and make better trading decisions.
What Is The Supertrend Indicator?
This powerful trend-following indicator will overlay on your chart like a moving average, and provide actionable buy and sell signals or the current trend direction.
How Does Supertrend Indicator Work?
The Supertrend indicator relies on the ATR, or average true range, to provide accurate readings. This means that you can customize it to account for volatile markets by adjusting the multiplier setting.
After that, you monitor the line on your chart. When prices close on the opposite of the line, were will see a change in the trend direction. When it turns red, it’s indicating a bearish trend and green indicates a bullish one.
How Reliable is Supertrend?
The indicator gives you an objective trend direction which is dependent on the setting you use. As long as a trader knows the limitation of using any technical tool, the reliability will be determined by how you execute your trading strategy.
Here are the key points for Stocks and Options traders to know:
- The changing colors of the Supertrend line determine the trend direction
- Buy signals are generated when the line flips to green due to closing prices being above the line
- A sell signal occurs when the price closes on the opposite side of the line – the crossover point
- The reliability of the Supertrend depends on how well a trader executes their trading strategy.
When it comes to accuracy in identifying market direction, few indicators are more reliable than the Supertrend indicator.
It has been proven time and again that its volatility-based approach allows traders to make predictions with high levels of confidence even in highly volatile markets.
What Are The Settings For The Supertrend Indicator?
When using the Supertrend indicator, you can adjust its parameters to suit your trading style. Changing the period setting, which is used for the ATR calculation, changes how much past data the indicator will use. A setting of 20 on a daily chart will use the past 20 days’ closing prices.
The factor is what the ATR value is set to. If the average range of the past 20 days is 3 and the factor is set to 2, the bands will be set at $6.00 from the price. If prices move that much against the indicator and close above or below it, the indicator will change color.
The Supertrend indicator calculation is very basic. It’s just the average of X period and an average true range calculation from that.
Best Supertrend Indicator Settings For Swing Trading
The default setting is a period of 10 and the factor is set to 3. Any changes to these numbers can affect the use of the Supertrend indicator.
Please note there is no best setting for any trend-following indicator.
As well, the more settings you change can lead to a trading system that is over-optimized for that point in time. Any changes to the Supertrend indicator much be back-tested before using real money.
There are some guidelines to think of when looking to change the default settings:
Smaller settings can make the indicator more reactive to a stock price which means, more trading signals. In a trending environment, this is not a bad thing for swing traders. Day traders using Supertrend may find more whipsaws and false trading signals on the lower timeframe charts.
Higher settings will remove the noise from the market at the risk of fewer trading signals.
Take a look at this daily stock chart with two sets of settings and the bottom being the quicker version.
Due to the faster settings, the bottom chart will react quickly to changes in price, but can also lead traders into trades that are during periods of consolidation.
Also, there is no best time frame and your choice will depend on how much time you can devote to trading.
2 Supertrend Trading Strategy You Can Test
This intraday trading strategy will use a combination of Supertrend indicators (2) and we will use settings that are different than the default for one of them.
Short-term parameters of 10, 3 | Longer-term parameters of 30,9 | Initial stop loss via ATR
You may want to change the color of one set of lines to avoid confusion. Let’s take a look at the strategy setup on the daily stock chart below.
The rules for the Supertrend trading strategy are simple:
Trade in the direction of the longer-term trend.
Buy and Sell Signals
Slower Supertrend lines will be the direction we will trade:
- Black is short and we will only look for sell signals
- Blue is long only and we only look for a buy signal
We will enter trades only when the short-term Supertrend flips in the direction of the longer-term trend which is a signal for this strategy.
Stop loss can be initially set at the shorter-term indicator reading.
We can also use a trailing stop on the short-term Supertrend line once the price advances a distance from your entry price.
You can also use price targets for profit using risk multiples depending on the setting you choose.
Day Trading With Supertrend Indicator
On the left, we are only allowed short trades as the longer-term Supertrend indicator is set to shorts only.
If the short-term indicator flips to green, we must ignore that setup using the basic strategy parameters.
Remember, our entry is a flip of the short-term indicator in the direction of the longer-term indicator. We do not enter on longer-term indicator flips.
For our purposes in this example, we will use 1R targets to exit for profits. 1 R is simply taking whatever we risk ($3.00) and looking for 1 X that amount which is $3.00
The trade at A is stopped out for a loss.
We then get a flip to a long-trend direction and are looking for long trades. The trade at B is stopped while the trade at C runs for a full 1R winner.
Finally, the trade at D also hits the 1R profit target.
On occasions, the short-term trend may shift after a big price surge or an unusually strong candlestick. This can lead to stop losses that are significantly larger than usual, making it difficult to hit a 1R target.
It’s up to you whether you will accept the increased size of your stop loss, pass on this trade altogether, or wait for corrective action such as either a bull flag or a bear flag.
Positional Trading and Re-Entry
The same settings can be used for longer-term trading but we need to have the means to re-enter a trending market since they can run for a while.
We can use the pattern of a trending market to re-enter any trade that gets stopped out without needing a flip in the indicator. This is an advanced trading technique that will require you to know the price structure.
After a substantial climb, this daily chart of crude oil futures began to go through a series of corrections and the short-term indicator changed color to red. Crude oil pulled back into an area where it had previously found support before heading back to the upside.
Once the price has taken a slight pause, it begins to make a lower high but then stalls. After breaking through this swing level and making another higher low you can confidently say that there is trending price action occurring.
From here your new stop loss should be placed below any of those previous swing lows.
Depending on your current exposure, a trader may use the flip to green as a trading signal for another position in the market.
What’s The Best Indicator To Use With Supertrend Indicator?
One of the best indicators to use with a Supertrend indicator is MACD (Moving Average Convergence/Divergence). MACD uses exponential moving averages and helps to identify momentum in the instrument to help with buying/selling decisions.
One way to use the MACD in a Supertrend indicator strategy is to look for crosses to the upside in the MACD and a green line on the trend indicator. Momentum is up, the trend is up, and we have a buy signal. Look for a break of a resistance area for the trade entry.
In addition, other indicators to consider are the Stochastics and RSI (Relative Strength Index), which are both momentum indicators as well.
The Supertrend indicator works well with a variety of technical indicators and I would lean towards momentum indicators and take advantage of divergence on the chart.
What Does Supertrend 7 3 Mean?
A common question is what the 7 3 means with the indicator. When you see these numbers, 7 is the look-back period and 3 is the factor (ATR multiplier).
The shorter the look-back period, the more responsive the indicator will be to changes in price.
Is Supertrend A Good Indicator? – Final Thoughts
A Supertrend indicator is a useful tool as it helps to identify the overall direction of price. It’s also a great strategy for buy and sell signals or even using multiple indicators together as a trading system.
By employing two indicators with different settings, we decrease our risk of taking potentially damaging whipsaw trades from false signals. We will have a long-term trend and a confirmation of a short-term trend in the same direction.
Traders who have an understanding of price movement, structure, etc, can look to add different variables to enhance the strategy. These same traders will also be able to define a ranging market and find the best charts to trade whether stock trading or trading options.
The fact that this indicator is based on volatility makes it an indicator I respect.
As always, proper risk management is vital and you can use the ATR to help position size to take advantage of more profitable trades.
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