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The supertrend indicator is a technical analysis tool used to identify market trends and potential entry or exit points. It is based on the Average True Range (ATR) and a multiplier, which helps track price movements and volatility.
By showing trend direction through a line on the price chart, the supertrend indicator helps traders understand whether the market is moving upward or downward, clearly explaining what is a supertrend indicator and how it reflects price movement.
Key Takeaways
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The supertrend indicator identifies trend direction using ATR and a multiplier.
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It shows buy and sell signals based on price position relative to the indicator line.
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Parameters like ATR period and multiplier affect sensitivity and signal frequency.
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It works best in trending markets and is often used with other indicators.
What is the Supertrend Indicator?
The supertrend indicator is a technical analysis tool that helps identify the direction of a market trend and potential entry or exit points. It is calculated using the Average True Range (ATR) along with a multiplier, which helps adjust the indicator based on market volatility.
The indicator is plotted as a line on the price chart, changing its position based on price movements. When the price moves above the line, it may indicate an uptrend, while a move below the line may suggest a downtrend.
How Does a Supertrend Indicator Work?
The Supertrend indicator relies on two key parameters: period and multiplier. But before we get into that, it is important to understand the concept of ATR or Average True Range. ATR is an indicator that measures market volatility by analysing the range of price movements over a specific period.
The true range is the highest of the following values (current high minus current low), the absolute value of the current high minus previous close and the absolute value of the current low minus previous close.
To calculate the ATR, we need to find the series of TR values first, and then divide the total by the number of periods represented by n. This way, you get the moving average of true ranges.
Supertrend Indicator Formula
Putting the information above in the formula for ATR, this is how it looks-
TR=Max [(current high –current low), Abs (current high – previous close), Abs (current low – previous close)]
ATR=(1/n) × ΣTRᵢ
Where,
“TRᵢ” is the true range
“n” is the number of periods or trading days
This formula is for us to understand the workings behind the indicator. But on most trading terminals, all you need to do is check the Supertrend indicator and pick the values for Periods (ATR number of days) and multiplier.
A multiplier is a value by which the ATR would be multiplied. Common default settings vary by platform. A multiplier of 3 is widely used, while ATR periods of 7, 10, or 14 are all common, depending on the platform and trading style. Traders should test parameter combinations against their specific instrument and timeframe rather than relying on a single default.
Smaller values of “n” can yield more signals and be more reactive to price changes. A larger value of “n” can reduce the market noise from day-to-day price action, leading to fewer signals to act upon.
Calculation Of A Super Trend Indicator
The supertrend indicator is derived using the Average True Range (ATR), which helps measure market volatility. It is plotted on the price chart to track trend direction by forming dynamic upper and lower bands. These bands adjust based on price movement and volatility.
Average True Range (ATR):
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Determine the True Range (TR) values using the defined formula.
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Calculate the ATR by taking the average of TR values over a selected period, while factoring in previous ATR values.
Super Trend Bands:
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Use the ATR along with a multiplier to compute the upper and lower bands.
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The multiplier decides how wide or narrow the bands are, depending on market volatility.
Upper band = (High + Low) / 2 + (Multiplier × ATR)
Lower band = (High + Low) / 2 − (Multiplier × ATR)
Super Trend Indicator Parameters
The super trend indicator uses two key parameters that influence how it reacts to price movements. These are the ATR period and the multiplier, which together determine the sensitivity of the indicator.
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ATR period: This defines the number of periods used to calculate volatility, commonly set at around 10 or 14. A lower value makes the indicator more responsive, while a higher value smoothens signals.
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Multiplier: This value, often set around 3, controls the distance of the bands from the price. A lower multiplier generates more signals, whereas a higher multiplier reduces signal frequency.
Adjusting these parameters changes how the super trend indicator behaves, so it is important to select values that align with your trading approach.
What Are the Popular Super Trend Indicator Strategies?
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Trend following strategy: Used to identify the overall market direction and take trades aligned with the trend after confirmation signals.
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Confirmation with other indicators: Combines the super trend indicator with tools like moving averages or RSI to validate signals and improve decision-making.
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Reversal trading strategy: Focuses on identifying possible trend reversals when the indicator shifts direction, helping spot early changes in momentum.
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Trading market reversals: Targets price corrections or turning points, where traders act on signals indicating a shift in trend direction.
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Combination of strategies: Involves using both trend-following and reversal approaches to adapt to different market conditions.
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Adaptation to trading style: Parameters like ATR period and multiplier are adjusted to suit short-term or long-term trading preferences.
Buy and Sell Signals
A supertrend indicator is plotted either above or below the closing price to signal a buy or sell. The indicator changes colour based on whether or not you should be buying.
If the supertrend indicator moves below the closing price, the indicator turns green, and it signals an entry point or points to buy. If a supertrend closes above, then the indicator shows a sell signal in red.
You will also note that the point where the buy or sell signal is generated is the crossover point. At that point, a buy signal is made, and the indicator turns green. At this point, the closing price is higher than indicator value. Similarly, when a sell signal is generated, and the indicator turns red, the closing price will be seen as lower than the indicator value.
Multiple Securities
The Supertrend indicator, developed by Olivier Seban, was designed as a general-purpose trend-following tool applicable across asset classes, including equities, commodities, currencies, and futures markets.
Support and Resistance
By the very nature of the supertrend indicator, it can act as a dynamic support and resistance level for traders. Additionally, it also provides signals for setting stop losses.
The way it works is, for example, when the buy signal (green) is on, when prices dip towards the indicator, traders may consider entering a long position at this level, which doubles up as a support level. Similarly, when the sell signal is on, in red, price points nearing or touching the indicator can act as levels of resistance.
What is an ideal level to set the stop-loss? If you have gone long, then a stop-loss can be set at a level below the green line. For a short position, the stop-loss is typically set just above the red (supertrend) line. If price rises back above the indicator line, it signals a potential trend reversal and the short position should be exited to limit losses.
Pros and Cons Of Using The Super Trend Indicator
The super trend indicator is widely used for identifying trends, but it has both advantages and limitations. The table below provides a clear comparison:
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Pros |
Cons |
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Helps identify market trends clearly using price movement. |
May generate false signals in sideways or low-momentum markets. |
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Adjusts to market volatility using ATR, making it adaptable. |
Being a lagging indicator, it reacts after price moves. |
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Simple to use and easy to interpret for different traders. |
Signals may be delayed, affecting entry and exit timing. |
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Can act as dynamic support and resistance levels. |
Requires proper parameter settings for effective use. |
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Useful for setting stop-loss levels and managing risk. |
Works better in trending markets, less effective in range-bound conditions. |
This comparison helps in understanding how the super trend indicator performs across different market situations and trading conditions.
Analyzing Supertrend Signals For Better Trading
The supertrend indicator provides signals based on its position relative to the price and helps identify trend direction. When the price moves above the indicator line, it generally reflects an upward trend, while a move below it indicates a downward trend. A change in the indicator’s position may signal a possible trend reversal.
Traders often use these signals to identify entry and exit points, but it is important to confirm them with other indicators or market analysis. This helps reduce the chances of acting on false signals, especially during volatile or sideways market conditions.
Conclusion
The supertrend indicator is a simple tool used to identify market trends and potential entry or exit points based on price movement and volatility. It uses ATR and a multiplier to adjust to changing market conditions. While it helps in understanding trend direction, it is more effective when used along with other indicators. Knowing its strengths and limitations can help traders use it more effectively.
