Last updated on April 20th, 2020
Trading with the trend is something we hear a lot about and it first requires defining a trend.
Using the Supertrend Indicator, you can objectively determine the state of the market which will make your trading easier.
The indicator will also present buy and sell signals which can be taken depending on the trading system you are using.
What Is The Supertrend Indicator and How Does It Work?
The Supertrend indicator 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.
Here is the Supertrend Indicator being applied to Tradingview charting.
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 oppositive side of the line, it flips from green to red and a sell signal is generated.
What Are The Parameters For The Supertrend Indicator?
Like all technical analysis tools, there are parameters that can be adjusted for your trading style.
Changing these settings 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 trading 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 backtested before using real money.
- Smaller settings can make the indictor more reactive to the 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 these two Forex charts on the 15 minute time frame.
The chart on the left has the standard settings while the chart on the right has a shorter period and a smaller multiplier (factor).
You can see the Supertrend indicator is currently in long mode on the right, while the slow is still in a downtrend.
- Intraday traders may want to use the quicker setting to allow more trading opportunities
- Positional traders would want to use a higher time frame and the standard setting is something you should test
How you use that information for trading setups and entries will depend on your trading plan.
A Supertrend Indicator Trading Strategy You Can Test
This intraday trading strategy will use two Supertrend indicators:
- Short term indicator parameters of 10, 3
- Longer-term indicator parameters of 30,9
- Initial stop loss via ATR
Let’s take a look at the strategy setup on the chart below of the 60-minute EURUSD Forex pair.
The rules for the Supertrend trading strategy are simple:
- Trade in the direction of the longer-term trend. This example is an uptrend and traders will ignore all short trades (turns red)
- Enter long trades when the short term indicator flips back to longs (turns green). Entry can be at the next candle open, break of highs, enter at the close.
- Initial stop loss is 2 X average true range. We need to be able to position size properly and the ATR has always been my “go-to” stop-loss method.
- Trail the stop loss on the short term Supertrend line once price advances
The example above ran 90 pips before price breached the trailing stop line.
We take our stops because we don’t know if the price is about to flip to shorts and we don’t want to give back too many profits.
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.
There will be times, especially on a higher time frame, that the short term Supertrend indicator does flip which can keep us out of the 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.
The yellow splash is where both indicators gave a buy signal which can put the odds more in your favor.
At the red X, the price would have hit our trailing stop loss and we would exit the trade. Notice there was no flip to red in the indicator.
Re-Entry Trading Rules For Longs (opposite for shorts)
- Place a buy stop order above the last swing high before the stop loss was hit
- Calculate the 2 X ATR stop-loss position using the last swing high before the stop was hit (see the dashed white line)
- Once buy stop is hit and you are long, continue to use the trailing stop feature of the indicator
Note that on the right side of the chart, after the stop-loss is hit, there is no break of highs.
We’ve also had a long trade fail which is to be expected regardless of your trading strategy.
What Did We Cover?
The Supertrend indicator is a volatility based indicator that shows the direction of the predominant price action.
We can use the indicator 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.
As always, proper risk management is vital and you can use the ATR to help position size your trades.