How to use a Supertrend indicator for trading

The Supertrend indicator is a highly sophisticated technical analysis tool traders widely use to identify the prevailing trend in the market. It is based on the concept of volatility and uses a combination of price and volatility to determine the direction of the trend.

This article will introduce the Supertrend indicator - explaining what it is, how it works, and most importantly - how traders can effectively use it in their trading strategy. Whether you’re a long-term investor looking to stay on the right side of major trends or an active trader looking for an edge in timing your entries and exits - a supertrend strategy has much to offer.

What is the supertrend indicator strategy?

A Supertrend indicator is an overlay plotted on price charts that uses volatility and price action to determine if the market is trending up, down, or moving sideways. The supertrend indicator formula incorporates the Average True Range (ATR) in its calculation and then plots a line above or below the price bars.

The supertrend line will change colour depending on the trend’s direction. The line changes to green during an uptrend and switches to red during a downtrend. This provides a visual way to assess the prevailing market trend at a glance.

The main functions of the Supertrend indicator are:

1. Identify the direction of the major trend
2. Show periods when the market is range-bound
3. Help time entries and exits as the trend changes direction

As a directional change indicator, the supertrend helps traders avoid trying to trade counter-trends or getting faked out by market noise. It can be used anytime, from short-term scalping to long-term position trading.

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Setting up the Supertrend indicator

The components for the supertrend indicator are the ATR period length and the ATR multiplier.

ATR period

The Average True Range period length determines how many bars are used to calculate short-term volatility. Typical values are between 10-15 bars. For example, you would set a 10-15 day ATR on a daily chart. On an hourly chart, a 10-15 hour ATR. And so forth.

Shorter ATR lengths will make the supertrend indicator more responsive to changes in volatility. At the same time, longer ATR lengths will make signal turns slower.

ATR multiplier

The ATR multiplier controls the sensitivity of the Supertrend indicator in identifying trends. Typical values range from 2-4 times the ATR.

Common values include:

• Conservative setting - 2 x ATR
• Moderate setting - 3 x ATR
• Aggressive setting - 4 x ATR

A higher ATR multiplier means fewer whipsaws but also fewer trade signals. A lower ATR multiplier generates more trading signals but can lead to more false signals and whipsaws.

Is the supertrend indicator accurate?

Most traders’ main question when considering a new trading indicator is, “How accurate is it?”. There is no universal accuracy level for the Supertrend indicator or any other technical tool because its effectiveness depends on how you use it and incorporate it into your strategy.

However, the supertrend can provide high-probability trading signals when used correctly. Due to its versatility, the supertrend has shown proven pattern reliability in extensive backtesting across different market conditions.

It remains remarkably accurate when used to trade with the direction of trends - not fade or counter-trade them. It reliably identifies periods when the major trend resumes after pullbacks during strong trending markets, providing very accurate entry signals.

Check this article about: What is a trading indicator and how it helps you as a trader?

How do you use a Supertrend indicator?

Here is a quick 3-step process for putting the Supertrend indicator into action:

Enter long positions when the supertrend line changes from red to green. This signals that market momentum has shifted from negative to positive, making it a high probability time to go long.

Enter short trades when lines change from green to red. The shift from positive to negative momentum indicates an opportune time to initiate a short position.

Use line crossovers for setting stop-loss points. Place protective stop-loss orders below the supertrend line on long trades and above the line for short trades. This gives the trend room to fluctuate while containing risk in the trade.

Supertrend pros and cons

Let’s summarize the main advantages and disadvantages of adding the Supertrend indicator to your charts:

Pros:

• Easy visual trend identification
• Helpful for momentum trading strategies
• Good for volatile markets
• Filters out market noise
• Versatile across time frames

Cons:

• Can generate false signals during range-bound price action
• Lagging - signals come after trend change begins
• Not ideal for fade trading counter-trends
• Requires fine-tuning inputs

As with all indicators, the supertrend is not a magic trading tool on its own. But when combined with a structured trading plan, it can be a valuable tool for timing entries, booking profits, and better identifying when major trends start and stall.

Put in the screen time to test it out on historical charts. Try different settings and find the combinations that fit with your strategy. This will allow you to maximize its benefits while avoiding the abovementioned drawbacks.

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In a nutshell,

The supertrend indicator is a robust technical analysis tool that can aid most trading styles. Its ability to identify the prevailing trend, combined with logical entry and exit signal points, gives traders an edge in navigating any financial market environment.

While no indicator will be accurate 100% of the time, the supertrend has shown proven reliability in efficiently capturing upside momentum during major trends. It helps eliminate guesswork by objectively plotting trend lines and volatility bands right on the price chart.

For traders looking to catch significant economic trends as they emerge and unfold, adding the Supertrend indicator to your toolkit is a wise move. Spend time learning how to combine it properly with other confirmation indicators to validate high-probability trade signals further.

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“When considering “CFDs” for trading and price predictions, remember that trading CFDs involves a significant risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be considered investment advice.