- May 12, 2022
- Posted by: CoachShane
- Category: Trading Article
Using the Supertrend Indicator, you can objectively determine the state of the market which will make your trading easier. Trading with the trend is something we hear a lot about and it first requires defining a trend.
It’s a technical indicator that will also present buy and sell signals as it flips colors which can be taken depending on the trading system you are using.
What Is The Supertrend Indicator?
The Supertrend is a trend following overlay on your trading chart, much like a moving average, that shows you the current trend direction. The indicator works well in a trending market but can give false signals when a market is trading in a range.
It uses the ATR (average true range) as part of its calculation which takes into account the volatility of the market. The ATR is adjusted using the multiplier setting which determines how sensitive the indicator is. Once the indicator is on your chart, you will see a line that turns red and green.
How Does It Work?
The changing colors determine the trend direction of the instrument you are trading. When the indicator flips to green due to the closing price being above the line, a buy signal is generated. Once price closes on the opposite side of the line, it flips from green to red and a sell signal is generated.
How Reliable is Supertrend?
Like all tools a trader will use, it will do the job it is designed for. In this case, it gives you an objective trend direction which is dependent on the values 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.
What Are The Settings For The Supertrend Indicator?
Like all technical analysis tools, there are parameters that can be adjusted for your trading style. Changing these values can make the indicator more or less sensitive to price movements. For the basic Supertrend settings, you can adjust period and factor:
+ The period setting is the lookback for the ATR calculation
+ Factor is the what the ATR is multiplied by to offset the bands from price
Ensure when you adjust any setting and implement in your trading strategy, you have tested the changes.
Are There Best Settings For Intraday or Positional Trading?
The default setting is a period of 10 and the factor being 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.
+ Smaller settings can make the indictor more reactive to a stock price which means, more signals
+ Higher settings will remove the noise from the market at the risk of less trading signals
Take a look at this daily stock chart with two sets of settings and the bottom being the quicker version.
While the bottom chart will react quicker to changes in price, it can also lead traders into a trend change during a consolidation period. Only you can determine if a faster setting is the best setting for your style and approach to trading.
Furthermore, there is no best time frame and your choice will depend on how much time you can devote to trading.
Supertrend Trading Strategy You Can Test
This intraday trading strategy will use two Supertrend indicators: 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. Higher Supertrend line black is short. Blue is long only
We will enter trades only when the short term Supertrend flips in the direction of the longer term trend
Stop loss can be initially set at the shorter term SI reading
Trail a stop loss on the short term Supertrend line once price advances. You can also use price targets using risk multiples.
Day Trading Stock Chart
On the left, we are only allowed short trades as the longer term indicator is set to shorts only. If the short term 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 flips.
For our purposes in this example, we will use 1R targets to exit for profits.
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 out while the trade at C runs for a full 1R winner. Finally, the trade at D also hits the 1R profit target.
There will be times that the short term trend changes on a gap up in price or on a very strong candlestick. At those times, the stop loss can be quite large which makes hitting a 1R target a challenge. You must decide whether you will accept the larger stop loss, skip the trade, or wait for some type of corrective action in the form of a bull or bear flag.
Positional Trading and Re-Entry
The same settings can be used for longer-term trading however we need to have the means to re-enter a trending market. We can use the pattern of a trending market to re-enter any trade that gets stopped out without a flip in the indicator. This is an advanced trading technique that will require you to have some knowledge of price structure.
This daily chart of crude oil futures, after a big move up, begins to retrace and the short term indicator turns red. You note that price pulls back into an area that supported price and began to rally. After a brief pause, price begins to put in a lower high but stalls. An entry on the break of the swing level confirms a new high being made after a higher low. This is the definition of trending price action. Your new stop loss will be below either swing low level.
Depending on your current exposure, a trader may use the flip to green as another position in the market.
Supertrend Indicator – Final Thoughts
The Supertrend indicator is a volatility based indicator that shows the direction of the predominant price action. We can use it for buy and sell signals as well as multiple plots of the indicator as a trading system. Using two indicators gives us a trend filter which can help decrease the number of whipsaw trades we take.
Traders who’ve 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.
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 your trades.