The Supertrend Indicator: A Comprehensive Guide for Beginners

The Supertrend indicator, developed by Olivier Seban, stands out as a widely adopted technical analysis tool within the trading community. Its primary function is to assist traders in identifying prevailing market trends and pinpointing potential entry and exit points for trades. The indicator is visually represented as a line plotted directly onto the price chart, dynamically shifting between green and red to signal the current trend direction. As its name implies, the Supertrend is particularly effective in markets that are exhibiting a clear directional movement or trend. Its simplicity and adaptability make it a suitable choice for traders of varying experience levels.

Understanding and Using the Supertrend Indicator

The Supertrend indicator's calculation is rooted in two fundamental dynamic values: the 'period' and the 'multiplier'. A crucial component of the Supertrend is the Average True Range (ATR), which is itself a technical indicator used to measure market volatility. The indicator incorporates the concept of Average True Range (ATR) to measure market volatility.

The ATR is calculated by first determining the True Range (TR) for each period. The True Range is the greatest value among the following: the difference between the current high and the current low, the absolute difference between the current high and the previous close, and the absolute difference between the current low and the previous close. To calculate the ATR, the series of TR values are first found, and then their moving average is calculated over a specified number of periods ('n').

While the underlying formula involves these calculations, on most trading terminals, all you need to do is check the super-trend indicator and pick the values for Periods (ATR number of days) and multiplier. Traders typically only need to input their preferred values for the ATR period (number of days) and the multiplier. The default settings often used are a multiplier of 3 and a period of 14 for ATR. These can be adjusted according to their preferences and trading strategies, potentially improving the indicator’s effectiveness for their specific needs. Choosing shorter values of n can bring up more signals and be more reactive to prices changes. A longer value of n can distil the noise of day-to-day price actions, and there will be fewer signals to act upon.

The Supertrend indicator generates buy and sell signals by plotting a line on the price chart. The indicator changes colour, based on whether or not you should be buying.

• If the super-trend indicator moves below the closing price, the indicator turns green, and it signals an entry point or points to buy. When the price is above the SuperTrend line, it indicates a bullish trend, and traders may consider entering long positions. You will also note that at the point where buy signal is made and the indicator turns green you will see, on hovering the cursor at this point, the closing price is higher than indicator value.
• Conversely, if a super-trend closes above, then the indicator shows a sell signal in red. When the price is below the SuperTrend line, it suggests a bearish trend, and traders may consider entering short positions. Similarly, when a sell signal is generated, and the indicator turns red, the closing price will be seen lower than the indicator value.

Beyond signaling entry and exit points, the Supertrend indicator also offers firm support and resistance levels for traders to enter and exit trades. By the very nature of the supertrend indicator, it offers firm support and resistance levels. The way it works is, for example when the buy signal (green) is on, when prices dip towards the indicator, you can enter or go long at this level, which doubles up as support level. Similarly, when the sell signal is on, in red, price points nearing or touching the indicator can act as levels of resistance. This characteristic provides traders with additional information for making trading decisions.

Though initially the super-trend indicator was primarily used by traders in the commodity markets, given its precision that takes into account volatility factor in prices, it became a popular indicator for other securities and asset classes including equities, futures and foreign exchange market.

Reliability and Combining with Other Indicators

While the Supertrend indicator is a valuable tool for identifying trends and managing risk, its reliability is not absolute and is influenced by market conditions, the specific asset being traded, and an individual's risk tolerance. The downside is, a super-trend indicator is more useful in trending markets where there are clear uptrends and downtrends in price. It may not be beneficial when markets are moving side-ways and may throw up false signals triggering wrong trades. Like most trend-following indicators, it may generate false signals during sideways or range-bound markets.

Therefore, to avoid false signals and gain a more robust understanding of market dynamics, it's best to use the supertrend indicator with other indicators. Combining multiple indicators can help reduce false signals and improve the overall performance of a trading strategy. Technical indicators should always be used with others for confirmation and better insight. Traders should consider using additional indicators or techniques to confirm signals and manage risk. For more efficient signals, super-trend is used in combination with other indicators like moving averages and MACD (moving average convergence divergence). Traders can incorporate the SuperTrend Indicator into various trading strategies. For instance, traders can use it in conjunction with other technical indicators, such as moving averages or oscillators, to confirm entry and exit signals. This combination of indicators in alignment can help reduce false signals and improve the overall performance of the trading strategy.

There are several technical indicators that can be effectively paired with the Supertrend. Some indicators that work well with it include moving averages, RSI, Bollinger Bands, MACD, volume indicators, a stochastic oscillator, Fibonacci retracement levels, and the Ichimoku Cloud.

A particularly effective combination involves using the Supertrend indicator alongside the Average Directional Index (ADX). The ADX is a trend strength indicator. By using the Supertrend to identify the direction of the trend and the ADX to confirm the strength of that trend, traders can increase their confidence in a potential trading signal.

The Importance of Setting Stop Losses

It is essential to acknowledge that no single indicator, including the Supertrend, is infallible. Market conditions can change rapidly, and unexpected price movements can occur. Therefore, incorporating robust risk management practices, such as setting stop losses, is crucial when using the Supertrend indicator.

Additionally, it also provides signals for setting stop losses. Using the SuperTrend Indicator for risk management can help traders protect their capital and minimize losses. The Supertrend indicator provides a convenient and dynamic way to determine stop-loss levels. Traders can use the SuperTrend line as a dynamic stop-loss level, adjusting it according to the market’s movements. What is an ideal level to set the stop-loss?

• If you have gone long (buy signal is on), then stop-loss can be set at a level below the green line. When the buy signal (green) is on, when prices dip towards the indicator, you can enter or go long at this level, which doubles up as support level.
• If you are planning to take a short position, you can hold on till the prices drop below the level aligned to the red line. When the price crosses the SuperTrend line, traders can close their positions to prevent further losses.

Using the Supertrend line as a dynamic stop-loss level enables traders to control their risk exposure while taking advantage of the prevailing market trend. This approach enables traders to control their risk exposure while taking advantage of the prevailing market trend.

In summary, the supertrend indicator is a widely used and versatile tool designed primarily to identify a market or asset's price direction. It provides clear buy or sell signals based on the direction of trends, clues about where to place stop losses, and adjusts itself to market volatility. It plots a line on the price chart, serving as a dynamic level of support or resistance, which flips its position relative to the price when a trend changes. However, like all indicators, it isn't foolproof, and its effectiveness can waver based on the asset being traded, market conditions, and your financial product strategy. That means it shouldn't be the only tool used to make investment decisions and works best when combined with other forms of technical analysis.