Supertrend Indicator Explained – Unlocking the Essentials

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A common problem with traders is finding the indicator with the best technical analysis to identify trades regardless of the parameters. Hence, it is no surprise that the supertrend indicator is one technical indicator that tops the list of the best trading indicators. 

In this piece, we dive into the operations of the supertrend indicator. Without leaving any stones unturned, we will discuss the significance, function, and mathematics of supertrend indicators. The goal is the supertrend indicator explained; however, this article also discusses false signals and how to avoid them. It’s a worthwhile read. Enjoy!

Understanding Technical Indicators

A technical indicator is a mathematical representation of data to identify financial movements. In trading, technical indicators play very key roles. See for yourself.

Role of Technical Indicators in Trading

With technical indicators, traders can access transparent trading data with the direction of price movements. Technical indicators also predict support and resistance levels of the prices of any asset. It may interest you that some indicators can project future prices by identifying upward and downward trends, enabling traders to make informed trading decisions.

Types of Technical Indicators

There are two categories of technical indicators; those whose data oscillate and those that overlay. Oscillators fluctuate between local highs and lows, gauging market momentum. The primary function of oscillators is to indicate price levels that are overbought or oversold. 

On the other hand, overlays detect extremes of overbought and oversold conditions. Overlay represents the balance between an asset’s supply and demand.

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What is the Supertrend Indicator?

As a trend-tracking price tool, the SuperTrend indicator was designed on the Maximum Adverse Excursion (MAE) principle. Let’s get into “the supertrend indicator explained” mode.

Definition and Purpose

True to its name, the supertrend indicator signifies the trajectory of price motion within a trending market. This indicator is illustrated on price charts to provide investors with a visual representation of ongoing price trends.

Calculation Methodology

The supertrend indicator is mathematical, so it involves a bit of calculation. But before we get into the calculations, let’s define a few terms of the supertrend indicator formula:

• ATR –  Average True Range (ATR) is the overall price range of an asset
• Period – This is the number of days the ATR is used, hence the term “ATR Period.”
• ATR period – This is the asset price range used to calculate the trend line.
• Multiplier – This is the value by which the ATR would be multiplied. 

Now, let’s get to the maths.

Computing the Supertrend involves entering the “ATR Period” and multiplying it by the “multiplier.” For instance, with an ATR period of 12, the indicator assesses the highs and lows from the past twelve days. The summation of high and low prices is divided by 2, and the resulting figure has the product of the multiplier and ATR value subtracted for uptrends and added for downtrends.

Significance of the Supertrend Indicator

The primary role of the SuperTrend indicator is to identify the market’s direction. Through thorough backtesting, the supertrend indicator has become an effective tool in predicting the price direction of stocks, futures, forex, bonds, and cryptocurrencies. More details are discussed in subsequent sections.

Identifying Trends and Direction

Traders can never overcome the importance of “trading with the trend.” This is precisely where the Supertrend indicator proves valuable. This tool aids in spotting and entering early into emerging trends.

The Supertrend indicator furnishes straightforward buy and sell signals determined by the interplay between the price and the indicator line. Buy signals materialize when the price surpasses the Supertrend line. In such instances, the Supertrend line functions as a dynamic support level, presenting an opportune moment for traders to initiate a long position.

Conversely, sell signals emerge when the price descends below the Supertrend line. The Supertrend line also assumes the role of a dynamic resistance level, serving as a potential entry point for a short position.

Volatility Measurement

Volatility is the movement expected from a market over a certain period. Because of its impact on price, volatility is often measured.

The average true range (ATR) is one of the best volatility measures. Traders adopt the ATR to protect their investments by using a volatility stop. This works by taking a multiple of the ATR, adding or subtracting it from the close, and placing the stop at this price. 

Other types of stops based on the volatility of the market are calculated about the highest high or lowest low over a fixed period, a swing chart which allows the market to move up and down inside of a trend, and a Gann angle which moves at a uniform rate of speed in the direction of the trend. These methods have proven to be efficient in measuring volatility.

Supertrend Formula Explained

The supertrend indicator formula involves two main components: the Average True Range (ATR) and a multiplier factor. As earlier indicated, the ATR measures volatility, while the multiplier adjusts the indicator’s sensitivity to market movements. Their mathematical formulas are:

Average True Range (ATR)

• How to calculate the True Range (TR) for each period: True Range (TR) = Max[(High – Low), |High – Close_prev|, |Low – Close_prev|]
• How to calculate the Average True Range (ATR) over the specified period: ATR = (ATR_prev * (period – 1) + TR_current) / period
• Please note that Close_prev is the previous closing price 

Multiplier Factor

• This is a user-defined value, often denoted as “Multiplier.”

Supertrend (Upper) Line

• Supertrend Upper Line = High + (Multiplier * ATR)

Supertrend (Lower) Line

• Supertrend Lower Line = Low – (Multiplier * ATR)

Basic Components of the Formula

As highlighted earlier, the supertrend indicator formula involves the following components:

• Average True Range (ATR)
• Multiplier Factor
• Supertrend (Upper) Line
• Supertrend (Lower) Line

A Step-by-Step Calculation Example

Let’s calculate the Supertrend indicator for Company ABC’s shares using a period length of 20 and a multiplier of 2 on a daily chart using the supertrend indicator formula.

 1: We will calculate the Average True Range (ATR) by –

• Gathering the high, low, and close prices for the last 20 trading days. 
• Calculating the True Range (TR) for each day using the formula: TR = Max(High – Low, |High – Previous Close|, |Low – Previous Close|)
• Calculating the 20-period ATR by averaging the TR values.

2: We will calculate the Basic Upper Band (Basic UB) and Basic Lower Band (Basic LB) by –

• Calculating the 20-day Simple Moving Average (SMA) of the closing prices.
• Basic UB = SMA + (ATR * Multiplier)
• Basic LB = SMA – (ATR * Multiplier)

3: We will calculate the Final Upper Band (Final UB) and Final Lower Band (Final LB) by –

• Asserting that for the first 20-day period, both Final UB and Final LB are equal to the Basic UB and Basic LB, respectively.
• Determining if the previous period was an uptrend or downtrend for subsequent periods.

If the previous period was an uptrend, then:

       – Final UB = Minimum of (Basic UB of the current period, Final UB of the previous period)

       – Final LB = Basic LB of the current period

If the previous period was a downtrend:

       – Final LB = Maximum of (Basic LB of the current period, Final LB of the previous period)

       – Final UB = Basic UB of the current period

4: We will calculate the supertrend value for each day –

• If the current day’s close price is higher than the Final UB of the previous day, then the Supertrend value is equal to the Final UB.
• If the current day’s close price is lower than the Final LB of the previous day, then the Supertrend value equals the Final LB.
• If neither condition is met, the Supertrend value equals the previous day’s Supertrend value.

5: We will repeat the above steps for each subsequent trading day to calculate the Supertrend values.

Parameters Affecting the Supertrend Calculation

The supertrend indicator offers traders customizable parameters. The first parameter is “Period.” Shorter periods lead to quicker reactions, while longer ones create smoother responses. The second parameter is the “Multiplier Factor.” A higher multiplier makes the Supertrend tolerant to price changes, while a lower multiplier makes the Supertrend a more sensitive indicator. Let’s see more details in the following sections.

ATR Period and Multiplier

The Average True Range (ATR) calculates the average of true ranges within a specific timeframe, measuring volatility while considering price gaps. Increased ATR often accompanies rapid price changes. On the other hand, a low ATR indicates minimal price fluctuations, which commonly happen during extended sideways price movement and reduced volatility.

Like the ATR, the Average True Range Multiplier (ATRX) is a basic trading tool. ATRX, however, goes a step further by multiplying ATR’s value by a user-defined factor.

Adjusting Parameters for Different Timeframes

Different traders have different trading goals; hence adjusting parameters happens very often. Adjusting parameters implies that the trader is fine-tuning the input values to adapt the indicator to varying market conditions and preferred trading strategies using paper trading apps like etoro.

Since multipliers determine the width of the bands around the price, traders may tweak it to be higher or lower. A smaller multiplier captures short-term price movements for shorter timeframes, while longer timeframes require a larger multiplier. For periods, shorter periods result in quicker reactions to price changes, while longer periods provide smoother signals. 

Interpretation of Supertrend Values

It’s no news that the supertrend indicator generates buy and sell signals by plotting a line on the price chart. As straightforward as this may seem, it requires some interpretation. So, let’s discuss the signals of the Supertrend indicator.

Understanding Supertrend Signals

The super-trend indicator is plotted above or below the closing price to indicate buy or sell actions. When the super-trend indicator moves beneath the closing price, it changes to green, signifying a buying opportunity. Alternatively, if the super-trend closes above, it displays a red “sell” signal.

The supertrend’s buy or sell signal establishes robust levels of support and resistance, aiding traders in trade entry and exit decisions. These signals also serve as guidance for effective stop-loss points.

Interpreting Crossovers and Trend Changes

The supertrend indicator does not exist as singular lines of perfection; hence, the lines in the price chart intersect from time to time. This is why crossovers exist. Crossovers indicate changing market momentum. When the main indicator crosses a predetermined signal line, this is a clear signal of shifting momentum in price action. A crossover occurs when a faster Moving Average crosses above a slower one, signifying a bullish crossover or below, indicating a bearish crossover. 

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Incorporating the Supertrend Indicator in Your Strategy

The SuperTrend indicator signals the direction of a trend, its continuation, or changes in direction. Thus, traders can incorporate the SuperTrend Indicator into various trading strategies. This combination can improve the overall performance of the trading strategy. Let’s see how.

Trend Following Strategies

Integrating the Supertrend indicator into trend-following strategies implies that traders will use the Supertrend indicator as a tool to identify and confirm trends. This is possible via:

• Indicator Setup: Set up the Supertrend indicator on your trading platform. Adjust the ATR period and multiplier to suit your preference.
• Identify the Trend: The Supertrend indicator can help traders determine the direction of the market trend. When the Supertrend line is below the price, it suggests an upward trend; when it’s above the price, it suggests a downward trend.
• Entry Signals: For a bullish trend-following strategy, consider entering a trade when the Supertrend line is below the price and indicating an upward trend. For a bearish trend-following strategy, enter when the Supertrend line is above the price and indicating a downward trend.
• Exit Signals: You can plan your exit strategy based on Supertrend reversals. If the Supertrend line changes direction against your trade, it signals an exit.

Swing Trading Strategies

Swing trading strategies capitalize on short- to medium-term price fluctuations. Traders who take advantage of said strategy aim to catch price movements while avoiding intraday noise. Thus, integrating the Supertrend indicator mt4 into swing trading strategies involves adapting its signals to the timeframes and goals of swing trading. Here’s how to go about it:

• Step 1: Select a period that aligns with your trading strategy. 
• Step 2: Adjust the parameters
• Step 3: Identify potential entry and exit points for your swing trades.
• Step 4: Use supertrend to confirm entry signals. 
• Step 5: Plan your exit strategy on supertrend reversals.

Supertrend as a Stop Loss Tool

We have emphatically mentioned Supertrend as a stop loss through severally in this piece. So, let’s examine how a supertrend indicator functions as a stop-loss tool.

Placing Stop Loss Levels with Supertrend

Placing stop-loss levels with the Supertrend indicator is to use it to adjust your stop-loss order as the trend progresses. What is the supertrend indicator if you can’t minimize losses? Here’s how to do it:

• Initial Stop-Loss Placement: When you enter a trade based on the Supertrend signal, place your stop-loss order slightly below the Supertrend line for a long trade or above the Supertrend line for a short trade.
• Trailing Stop-Loss: As the trend continues, you can use the Supertrend indicator to trail your stop-loss order to lock in profits.
• Maintaining a Gap: To prevent minor price fluctuations, maintain a certain gap between your stop-loss order and the Supertrend line.
• Exiting on Reversals: If the Supertrend line reverses direction against your trade, it’s a signal to exit the trade, so you can keep your profits.

Trail Stop Strategy with Supertrend

Implementing a trailing stop strategy with the Supertrend indicator mt4 is to adjust your stop-loss order and lock in profits as the trend progresses. Here’s how to create such a strategy:

• Step 1: Place your stop-loss order according to your risk tolerance and the Supertrend line. 
• Step 2: Decide on a trailing distance.
• Step 3: As the price moves, continue monitoring and adjusting your stop-loss order to match the Supertrend line.
• Step 4: Maintain a reasonable trailing distance 
• Step 5: If the Supertrend line reverses direction against your trade, it could indicate a potential trend reversal. In this case, consider exiting the trade to lock in profits or minimize losses.

Supertrend in Combination with Other Indicators

Pairing the Supertrend indicator with other indicators has been reported by traders to improve trading strategy insights. Indeed, what is the supertrend indicator without other indicators? Here are the top five indicators that traders combine with the Supertrend indicator.

• Relative Strength Index (RSI): By combining it with a Supertrend indicator, traders can validate reversal points.
• Moving Average Convergence Divergence (MACD): When combined with Supertrend, traders report their confidence in trades increases.
• Bollinger Bands: Combining them with Supertrend indicators helps traders to recognize entry points.
• Fibonacci Retracement Levels: Merging them with Supertrend assists traders in precise entry/exit action.
• Volume Indicator: When Supertrend is combined with higher volume, traders can expect a robust trend direction.

Moving Averages and Supertrend

The SuperTrend indicator may appear like a moving average because it tracks price action. However, its calculation and function are more intricate.

Beyond a moving average, structure strategies created using scorecards, indices, or simultaneous conditions aid in the mathematics of the Supertrend calculation. However, combining indicators and techniques such as moving averages is crucial for a robust trading strategy. Thus, it’s best to- 

• Buy when the market price rises above SuperTrend while staying above the moving average.
• Sell when the market price drops below SuperTrend while staying below the moving average.

RSI and Supertrend

The Relative Strength Index (RSI) is a versatile technical indicator. Its role extends to being a contrarian signal with extreme values that indicate trading opportunities.

While the Supertrend effectively detects shifts in market trends and identifies optimal entry points, it has a notable limitation: difficulty pinpointing optimal exit points. Consequently, integrating RSI and Supertrend by utilizing the RSI’s highest and lowest price rebound points can aid traders in identifying superior exit points for their strategies. 

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Choosing the Right Timeframes and Markets

What is the supertrend indicator without the right time frames and markets? When selecting optimal chart timeframes for trading, remember that they depend on your trading style, preference and the instrument’s liquidity. Let’s dive into timeframes and markets, shall we?

Adapting Supertrend to Short-Term and Long-Term Trading

The Supertrend indicator mt4 can be adjusted for short-term and long-term trading by modifying its parameters based on different timeframes. Short-term traders use smaller and tighter settings to catch rapid movements using day trading apps, while long-term traders opt for larger intervals and broader settings to capture significant trends. Some traders also choose longer-term charts for analysis, affording them more time to make an ideal trading decision.

Applying Supertrend in Different Financial Markets

As with adapting Supertrend indicators to long and short-term trading, traders can also apply the Supertrend indicator across various financial markets, forex, commodities, cryptocurrencies, or penny stock apps by following these steps:

• Step 1: Use a trading platform that supports the Supertrend indicator mt4 like eToro.
• Step 2: Calculate ATR and select parameters for the Supertrend indicator
• Step 3: Apply the Supertrend indicator to your trading chart and interpret the Signals
• Step 4: Implement Stop Loss and Take Profit
• Step 5: Backtest the Supertrend strategy on historical data to see how well it performs

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Managing False Signals and Whipsaws

The Supertrend indicator is an ideal tool for predicting price; however, there are cases where the data may be falsely represented, and the signals will be false. This can affect a trader’s decisions and cause loss. Hence, managing false signals and whipsaws is crucial in trading and investing. Read the subsequent sections to find ways to minimize false signals.

Identifying and Minimizing False Signals

To identify and minimize false signals, use multiple technical indicators, higher periods, and price patterns. It’s also important for you to verify signals with volume indicators, wait for confirmation before making a decision and set appropriate stop-loss levels.

Confirming with Additional Analysis

The data on the Supertrend indicator will not always be straightforward; thus, additional analysis is a valuable tool to confirm signals and manage false signals and whipsaws. Other analyses to consider are:

• Candlestick Patterns
• Support and Resistance
• Fibonacci Retracements
• Divergence between indicators
• Sentiment indicators

Backtesting and Optimization

Backtesting and optimization are very important aspects of any trading strategy.  It evaluates a trading strategy via historical data by simulating past trading conditions. This helps traders gauge the strategy’s effectiveness and performance. On the other hand, optimization enhances functionality. Let’s dive into the importance and parameters for maximum effectiveness.

Importance of Backtesting with Supertrend

Backtesting with Supertrend is important for traders as it allows you to test your Supertrend strategy via historical data. Hence, you can identify the strengths and weaknesses of the strategy.

Backtesting also allows traders to optimize the parameters of the Supertrend indicator, quantify a whipsaw, and project ways to minimize its impact. Backtesting allows traders to make only data-driven decisions that ascertain smart investment choices.

Optimizing Parameters for Maximum Effectiveness

To optimize parameters for maximum effectiveness with supertrend indicators, traders must find the right values for the period and multiplier that suit the specific market and period. To start, traders must understand the role of the parameters and select an ideal timeframe. Next, they will collect historical price data of their preferred timeframe, define their optimization goals and decide on a range of values for the period and multiplier they wish to test. 

Next, traders will test various combinations of period and multiplier values within their defined ranges, plot and observe the Supertrend indicator on historical price charts with different parameter values and adjust the parameters based on prevailing market conditions.

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Risk Management and Position Sizing

Risk management is an important part of asset trading in the financial market. In using the Supertrend indicator, risk and position sizing are essential factors traders should consider. Here’s how to trade smart.

Incorporating Supertrend into Risk Management Strategies

Incorporating the Supertrend indicator into your risk management strategies can enhance your trading approach. With the following simple Supertrend practices, you will save yourself a world of troubles:

• Use the Supertrend to confirm the direction of the prevailing trend before entering a trade.
• Incorporate the Supertrend as a filter to avoid taking trades during high volatility
• Use Supertrend for Stop-Loss Placement
• Modify your position size based on the Supertrend’s signal strength.
• Use Supertrend signals to manage your exit strategy.
• Combine the Supertrend with other indicators or technical analysis tools using the supertrend indicator settings.

Determining Position Sizes Based on Supertrend Signals

Supertrend signals are influenced by risk tolerance, account size, and market volatility. Hence, to determine position sizes based on Supertrend signals, you will need to follow these steps:

• Step 1: Calculate ATR
• Step 2: Determine the percentage of the trading capital you can risk on a single trade
• Step 3: Multiply the ATR by the predefined risk percentage
• Step 4: Determine where your entry price will be based on the Supertrend signal.
• Step 5: Divide the dollar risk by the difference between the entry and stop loss prices via the supertrend indicator settings.
• Supertrend indicator explained – eToro Complete Guide

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Supertrend indicator explained – eToro Complete Guide

The Supertrend indicator is one technical indicator available on reputable trading platforms. Apart from being a commodity trading app , eToro is an outstanding platform where traders can learn the effective use of the Supertrend indicator. Here are the simple steps to signing up on eToro:

• Step 1: Visit eToro “Join Now” page

• Step 2: Choose a username, enter your email address, and set a password. 
• Step 3: Read the Terms and Conditions, Privacy Policy, and Cookie Policy, and tick the boxes.
• Step 4: Click on the ‘Create Account’ button.
• Step 5: Check your email inbox and verify your email address.

Supertrend indicator explained – Conclusion

The Supertrend indicator is a unique technical indicator that eases the stress of trading. Every trader, novice or experienced, should use the Supertrend indicator to ease their trading experience.

It’s a good thing the Supertrend indicator is a versatile tool for different assets; it can also be accessed on reputable trading platforms and free stock apps like eToro. With a simple sign-up process on eToro, you will have the Supertrend indicator at your fingertips.

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