The Supertrend Indicator is a widely used tool for traders to spot market trends. By integrating the Average True Range (ATR) with a multiplier, it calculates its value, offering insights into trend direction. This indicator aids traders in making informed decisions by providing a clear understanding of market movements and potential entry and exit points in asset trading.
Here, we will explore the super-trend indicator in detail, including its parameters, formula, trading strategy, and examples.
How does a super-trend indicator work?
The Super Trend Indicator, which is a valuable tool for traders, combines the Average True Range (ATR) with a multiplier to calculate its value. Here’s how it operates:
1. Average True Range (ATR):
- The ATR measures market volatility by considering the range between the highest and lowest prices during a specified time frame.
- It also factors in the closing price of the asset.
- ATR helps traders understand the price movement range and potential volatility.
2. Supertrend calculation:
- The Supertrend Indicator computes a dynamic line on the price chart. This line acts as a level of support or resistance.
- The formula for the Supertrend Indicator is as follows:
Super trend indicator formula:
The super-trend indicator relies on the ATR to gauge a security's volatility. The ATR is calculated using a sequence of True Range (TR) values. The TR value is determined by finding the maximum of three values:
TR = {(current high − current low, absolute (current high − previous close), absolute (current low − previous close)}
Once the TR values are obtained, the ATR is calculated using the following formula:
ATR = [(Prior ATR × 13) + Current TR] / 14
Traders use this formula to understand the market's volatility, a crucial factor in determining potential trends and reversals.
Additional read: Swing Trading Indicators in Stock Market
Calculation of super trend indicator
Average true range (ATR):
- Identify the sequence of TR values using the formula mentioned above.
- Apply the ATR formula to calculate the ATR, incorporating the prior ATR value and the current TR.
Super-trend bands:
- Utilise the ATR in the super-trend formula to calculate the upper and lower bands.
- The multiplier is a key factor in determining the width of the bands and adjusting to market volatility.
Upper band = (High + Low/2) + multiplier × ATR
Lower band = (High + Low/2) – multiplier × ATR
Super trend indicator parameters
- Traders open a chart, input the super-trend indicator, and choose the multiplier and periods (ATR number of days).
- Common multipliers used are 3 and 10 periods, depending on the trader's risk tolerance and market conditions.
Example
Consider an example with stock XYZ in the Indian stock market.
Data:
- ATR period: 14 days
- Multiplier: 2.5
Calculation:
- Calculate ATR using the sequence of TR values over the past 14 days.
- Apply the ATR in the super-trend formula to calculate the upper and lower bands.
Trading scenario:
- If the closing price consistently surpasses the upper band, it signals a strong uptrend.
- Conversely, if the closing price falls below the lower band, it may indicate a potential reversal.
Traders use the super-trend indicator's dynamic nature to adapt to changing market conditions, providing valuable insights into trend strength and potential reversal points in the Indian stock market and beyond.
Additional read: Williams %R Indicator: Definition, Formula
Pros and cons of using the super-trend indicator
Technical analysis tools like the super-trend indicator offer traders valuable insights into market trends and potential entry and exit points. However, like any tool, it comes with its own set of advantages and disadvantages.
Pros
- Trend identification:
Clear trend signals: The super-trend indicator provides clear signals for identifying trends. Traders can easily recognise whether the market is in an uptrend or downtrend. - Adaptability:
Dynamic adjustments: The use of ATR makes the super-trend adaptable to changing market conditions. The indicator's bands adjust to volatility, offering a more responsive representation of price movements. - Simplicity:
Ease of use: The formula is straightforward, and the indicator is easy to implement on charting platforms. Traders, including those with less technical expertise, can incorporate it into their analysis. - Versatility:
Applicability to various assets: The super-trend indicator is versatile and can be applied to different financial instruments such as stocks, currencies, commodities, and cryptocurrencies. - Risk management:
Support for risk management: The indicator can be useful for setting stop-loss levels, aiding traders in managing risk by providing potential exit points.
Cons
- Whipsaw effect:
False signals: In choppy or sideways markets, the super-trend may generate false signals, resulting in whipsaws. Traders may initiate trades based on misleading indications, leading to losses. - Late entry or exit:
Lagging nature: Like many trend-following indicators, the super-trend may lag in recognising trend changes. Traders relying solely on the indicator may enter or exit positions later than desired. - Optimisation challenges:
Sensitivity to parameters: Traders need to choose appropriate values for the multiplier and ATR period. Finding the right balance can be challenging, and what works well in one market condition may not be optimal in another. - Market-specific limitations:
Not universally applicable: While popular in certain markets, the super-trend indicator may not perform equally well in all market conditions or for all financial instruments. - Dependence on volatility:
Market volatility impact: The super-trend heavily relies on market volatility, and extreme volatility can lead to wide bands, potentially generating more signals but also increasing the risk of false signals.
How to identify buy and sell signal using super trend indicators?
Here's how you can identify buy and sell signals using the Super Trend indicator:
1. Buy signal (green):
- When the super trend line moves below the closing price, it turns green, suggesting a bullish trend.
- This condition indicates that the market is in an uptrend, and it signals an entry point for buying.
- Traders may consider opening a long position when they see this green signal.
2. Sell signal (red):
- Conversely, when the super trend line closes above the closing price, it turns red, indicating a bearish trend.
- This condition suggests that the market is in a downtrend, and it signals an entry point for selling.
- Traders may consider opening a short position when they see this red signal.
3. Managing trades:
- The super trend indicator also serves as a dynamic stop-loss level. As the price moves, the super trend line adjusts accordingly.
- For a long position, if the super trend line turns from green to red, it may be considered a signal to exit the long position.
- For a short position, if the super trend line turns from red to green, it may be considered a signal to exit the short position.
4. Parameter adjustment:
- Traders may need to adjust the ATR multiplier based on the volatility of the specific market. Higher multipliers result in wider super trend lines, accommodating more price fluctuations.
Additional read: What is Fear and Greed Index
Trading strategy using super trend and moving average crossover
Buy signal:
A buy signal is generated when two conditions are met simultaneously:
- The super trend indicator changes to green, indicating a bullish trend.
- The 5 EMA crosses above the 20 EMA, suggesting a short-term momentum shift to the upside.
Sell signal:
A sell signal is generated when two conditions are met simultaneously:
- The super trend indicator changes to red, indicating a bearish trend.
- The 20 EMA crosses above the 5 EMA, suggesting a short-term momentum shift to the downside.
Conclusion
The super-trend indicator is a valuable tool for traders seeking to identify and follow market trends. However, like any technical indicator, it is essential for traders to use it in conjunction with other analysis methods and consider its limitations. Understanding the pros and cons of the super-trend indicator allows traders to make more informed decisions and improve their overall trading strategy.
