Introduction
Are you interested in learning about a straightforward and powerful method to track market trends? If so, then using the SuperTrend indicator may be worth considering. In this article, we will provide an overview of the SuperTrend indicator, how it is computed, and how you can employ it for trading purposes.
Developed by Olivier Seban, the SuperTrend indicator is a trend-tracking tool that operates similarly to moving averages. Unlike moving averages, however, it is depicted above or below the price chart, depending on the trend direction.
Looking for information on SuperTrend stock screener? Click here.
How to compute the SuperTrend indicator?
The SuperTrend indicator requires two inputs, viz. the period and multiplier. The period determines the number of bars used to calculate the average true range (ATR), which measures price volatility. Meanwhile, the multiplier determines the distance between the SuperTrend line and the price. By default, these parameters are set at 10 and 3, respectively.
The SuperTrend indicator is computed as follows:
- Compute the basic upper band by adding the product of the multiplier and ATR to the average of high and low prices (HL2).
- Compute the basic lower band by subtracting the product of the multiplier and ATR from HL2.
- Determine the final upper band by taking the minimum of the previous final upper band and basic upper band, except when the previous close was above the previous final upper band, in which case use the basic upper band.
- Determine the final lower band by taking the maximum of the previous final lower band and basic lower band, except when the previous close was below the previous final lower band, in which case use the basic lower band.
- Determine the SuperTrend line by using the final lower band if the trend direction is up, or the final upper band if the trend direction is down. The trend direction is determined by comparing the previous SuperTrend line with HL2.
There are many software programs (like ChartAlert) that can automatically calculate and chart and scan the SuperTrend indicator.
How does the SuperTrend indicator work?
The SuperTrend indicator follows an asset’s price movements and changes color based on the trend direction.
The indicator employs two parameters: the average true range (ATR) and a multiplier.
The ATR measures the price’s volatility, while the multiplier determines how the indicator responds to price fluctuations.
The default values for these parameters are 10 for the ATR period and 3 for the multiplier, but you can customize them to fit your preferences and trading style.
How is the SuperTrend indicator interpreted?
When the price is above the SuperTrend line, the line turns green, signaling an uptrend.
When the price is below the SuperTrend line, the line turns red, indicating a downtrend.
The SuperTrend line changes from green to red when the price closes below the line minus the ATR multiplied by the factor.
The SuperTrend line changes from red to green when the price closes above the line plus the ATR multiplied by the factor. This helps traders identify when a trend is reversing, potentially signaling a good time to enter or exit a trade.
It’s important to note that the SuperTrend should not be used as the sole basis for making trading decisions, and it’s important to use it in conjunction with other technical indicators and fundamental analysis.
The SuperTrend indicator is versatile and can assist you in identifying and monitoring trends across various timeframes and markets. Additionally, it can generate buy and sell signals based on its position relative to the price and color. A green SuperTrend line moving below the price signifies an uptrend, indicating potential buying opportunities. Conversely, a red SuperTrend line moving above the price indicates a downtrend and could indicate opportunities to sell. You can also utilize the SuperTrend line as a dynamic stop-loss level by placing your stop accordingly.
How to use the SuperTrend indicator for trading?
The SuperTrend indicator can help traders identify the direction and strength of a trend. It can provide signals for entry and exit points, as well as stop-loss levels. It can be used in various ways to enhance your trading performance. Here are some of the most common ways to use it:
Plot the SuperTrend indicator on your price chart
The SuperTrend indicator is usually plotted on the price chart as a line or band. It is calculated using the Average True Range (ATR) and the multiplier factor. The SuperTrend indicator line changes color when the trend changes direction.
Identify the trend direction
The SuperTrend indicator helps you identify the trend direction of the asset you want to trade. When the indicator line is above the price, it indicates a downtrend, and when it is below the price, it indicates an uptrend.
Trend confirmation
You can use the SuperTrend indicator to confirm the direction and strength of a trend. If the price is above a green SuperTrend line, it means that the trend is bullish and strong. If the price is below a red SuperTrend line, it means that the trend is bearish and strong. You can also look at the slope of the SuperTrend line to gauge how fast or slow the trend is moving.
Trend reversal
You can use the SuperTrend indicator to spot potential trend reversals. When the SuperTrend line changes color from green to red or vice versa, it signals that a trend reversal may be occurring. You can also look for divergences between the price and the SuperTrend line to anticipate a trend reversal. For example, if the price makes a higher high but the SuperTrend line makes a lower high, it indicates a bearish divergence and a possible downtrend reversal.
Look for trade signals
When the SuperTrend indicator changes direction, it can generate a trade signal. For example, if the indicator changes from an uptrend to a downtrend, it may signal a sell trade. Conversely, if the indicator changes from a downtrend to an uptrend, it may signal a buy trade.
Entry and Exit points
You can use the SuperTrend indicator to identify optimal entry and exit points for your trades. If you are trading with the trend, you can enter a long position when the price crosses above a green SuperTrend line or enter a short position when the price crosses below a red SuperTrend line. You can exit your position when the price crosses in the opposite direction of your trade or when the SuperTrend line changes color. Alternatively, you can use other indicators or price patterns to confirm your entry and exit signals.
Stop-loss Levels
Once you have entered a trade based on the SuperTrend indicator, it is important to set your stop loss and take profit levels. You can use the indicator line as a trailing stop loss level, which means you move the stop loss level as the indicator line moves in the direction of your trade. You can also use the indicator line as a take profit level, which means you exit the trade when the indicator line reaches a certain level.
Also see: How to set up stop loss and take profit levels in trading
Manage your risk
Trading always carries risk, so it is important to manage your risk properly. You can use position sizing, stop loss, and take profit levels to manage your risk. You can also use risk-reward ratios to ensure that your potential profit is always greater than your potential loss.
By incorporating the SuperTrend indicator into your trading strategy, you can gain a better understanding of market trends and improve your decision-making process. However, remember to test your strategy thoroughly and use the indicator in conjunction with other technical and fundamental analysis tools for more accurate and reliable results.
Advantages & Limitations of SuperTrend Indicator
The SuperTrend indicator is a widely used tool in technical analysis that offers several benefits and some limitations to traders. Here are some of the advantages and disadvantages of using this tool:
Advantages
- Trend direction identification: One of the primary benefits of the SuperTrend indicator is its ability to identify the trend direction of an asset. This feature can be particularly useful for traders who want to enter and exit trades at the right time.
- User-friendly: The SuperTrend indicator is designed to be user-friendly, and it can be used by both novice and experienced traders. Additionally, it is available on most trading platforms and can be customized to meet individual traders’ needs.
- Clear buy and sell signals: The SuperTrend indicator provides traders with clear buy and sell signals based on the direction of the trend. This feature makes it easier for traders to make informed decisions.
- Effective in trending markets: The SuperTrend indicator is particularly effective in trending markets as it can help traders stay on the right side of the trend and maximize profits.
Limitations
- False signals in choppy markets: The SuperTrend indicator can generate false signals in choppy markets or when an asset is trading in a range. This situation can result in traders entering and exiting trades at the wrong time and suffering losses.
- Limited effectiveness in volatile markets: The SuperTrend indicator may not be as effective in volatile markets, as sudden price movements can make it difficult for the indicator to generate accurate signals.
- Lagging indicator: The SuperTrend indicator is a lagging indicator, which means it may not accurately predict future price movements. Traders who rely solely on the SuperTrend indicator may miss out on potential profits.
- Requires other indicators for confirmation: To improve accuracy, traders should use the SuperTrend indicator in combination with other indicators to confirm trading signals. Relying solely on the SuperTrend indicator to make trading decisions may be unwise.
The SuperTrend indicator is a popular technical analysis tool used by traders to identify trends and potential trend reversals, as well as to determine optimal entry and exit points for their trades. By using the SuperTrend indicator, traders can confirm the direction and strength of a trend, spot potential trend reversals, and set stop-loss levels based on their risk-reward ratio. Its flexibility and ease of use make it a valuable addition to any trading strategy.
No trading indicator can guarantee profits or be used as the sole basis for making trading decisions. The SuperTrend indicator, like any other technical analysis tool, has limitations and can generate false signals. It is important to combine it with other indicators, price patterns, and fundamental analysis, as well as to manage your risk and follow a disciplined trading plan. It is recommended to practice with a demo account and seek professional advice before investing real money.
For examples of customizable SuperTrend Indicator factory scans that can be edited, modified, or revised, and subsequently scanned through ChartAlert’s native stock screener or technical analysis scanner, click here.