What is a Super Trend Indicator?

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.

Significance of super trend indicators

A super trend indicator is primarily used to determine the overall direction of the market rather than using it to time precise entry or exit points. It's a versatile tool, and traders use it across various markets, such as stocks, futures, forex, and bonds. It is worth mentioning that this tool was originally designed for commodities. However, with time, it has proven highly accurate for other asset classes as well.

Also, it must be noted that while the super trend indicator is useful for identifying market trends, it can sometimes give incorrect signals, especially during periods of high market volatility. These false signals suggest a trend change that doesn't actually happen.

Therefore, to use the indicator effectively, traders should be patient and wait for a confirmation signal. This confirmation usually occurs within a day or two and helps to avoid making premature trades based on misleading signals.

When it comes to new traders, the super trend indicator is an excellent introduction to trend-following strategies. That’s because it simplifies the process by helping traders identify the market direction using multiple time frames. Additionally, one of the most significant advantages of the super trend indicator is its simplicity and accuracy in identifying trends and potential reversals. It doesn't require constant adjustment based on recent price action. This versatility makes it a reliable tool across different time frames.

Moreover, when combined with a solid understanding of support and resistance levels, the super trend indicator also allows traders to make quick decisions on whether to go long, short or stay out of the market altogether.

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 a super trend indicator

The super trend indicator is calculated using the Average True Range (ATR). It is plotted on the price chart to determine market direction. Primarily, its calculation involves determining the upper and lower bands. These bands help to identify the expected trend reversals.

For more clarity, let’s study the calculation of the super trend indicator in detail:

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

Ideally, the super trend indicator uses two main parameters: the period, which is set to 10, and the multiplier, which is set to 3. These settings control how the indicator reacts to price movements.

Be aware that adjusting these settings changes how the super trend indicator behaves. For example,

• If you reduce these values, the indicator will become more sensitive to price changes. It will give more frequent signals, but not all of them may be accurate.
• On the other hand, if you increase these values, the indicator will be less sensitive to price changes. This reduces the chances of false signals but might also mean you get fewer trading opportunities.

Therefore, as a tip, it is also important to find a balance that works best for your trading strategy.

Example of a super-trend indicator

Consider an example with stock XYZ in the Indian stock market.

1. Data:

• ATR period: 14 days
• Multiplier: 2.5

2. 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.

3. 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

Why is the super-trend indicator important?

Several traders use the super trend indicator to spot market trends and gain clear trading signals. Also, it assists in risk management and reduces guesswork. In this way, it enhances the chances of attaining success in the market. For a greater understanding, let’s study why the super-trend indicator is a valuable tool for traders:

Identifying trend direction

Be aware that you can make informed trading decisions only after knowing the current trend direction. That’s because such knowledge guides whether to focus on buying or selling.

By using the super trend indicator, you can easily determine whether the market is in an uptrend (bullish) or downtrend (bearish). It shows the prevailing trend by analysing price movements and volatility.

Clear buy and sell signals

This indicator provides easy-to-interpret buy and sell signals. It shows traders the best points to enter or exit trades based on the identified trend. These signals reduce the uncertainty and guesswork often associated with trading.

Therefore, traders using it often take more accurate and confident trading decisions.

Assisting in risk management

The super trend indicator also helps in managing risk. It does so by creating dynamic support and resistance levels with its upper and lower bands.

As a trader, you can use these levels to place stop-loss orders. For those unaware, such stop-loss orders help to protect against significant losses if the market moves against their position.

Maximising profit potential

Super trend indicators show clear market trends and provide precise entry and exit signals. Also, they help in risk management, which leads to increased profitability.

Thanks to this combination of benefits, it is often perceived as a valuable tool for maximising gains in the market.

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

1. 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.
2. 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.
3. 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.
4. 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.
5. 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

1. 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.
2. 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.
3. 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.
4. 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.
5. 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.

What are the popular super-trend indicator strategies?

As mentioned earlier, the super trend indicator is a versatile tool. It is widely used by traders to identify trends, confirm signals, and spot potential reversals. This versatility makes it a key component in various trading approaches. Now, let’s check out some popular trading strategies you can implement using the super trend indicator:

Trend following strategy

In this strategy, traders use the super trend Indicator to identify the current market trend, whether it's upward (bullish) or downward (bearish). Next, they enter trades that align with this trend. By doing so,  traders capture most of the trend's movement.

While implementing this strategy, the key is to wait for a confirmed signal from the super trend indicator before entering a trade. This helps to maximise profits by riding the trend for as long as it lasts.

Confirmation with other indicators

It must be noted that most traders combine the super trend indicator with other technical indicators (such as moving averages or RSI) to increase the reliability of their trades. In this strategy, they use these additional tools to confirm the trend direction as indicated by the super trend.

When multiple indicators agree on a trend, the likelihood of a successful trade increases. This helps calculate more accurate entry and exit points.

Reversal trading strategy

In this strategy, you spot the expected trend reversals using the super trend indicator. To do so, you, as a trader, look for signals that the current trend is losing momentum and may soon change direction. When the super trend indicator shifts from indicating a bullish to a bearish trend (or vice versa), it suggests a possible reversal. At this turning point, traders can enter trades and earn profit from the new emerging trend.

Capitalising on market reversals

This strategy is built on the idea of “reversal trading”. It specifically targets market corrections or trend changes as identified by the super trend indicator. While practising this strategy, you look for optimal points where the market may reverse after an extreme move.

Then, you enter trades at these reversal points. In this way, you benefit from the market's natural tendency to correct itself. Ultimately, it leads to profitable trading opportunities.

Combination of strategies

Some traders prefer to combine trend-following and reversal strategies. They prefer adapting their approach based on current market conditions. This flexibility allows them to switch between capturing long trends and taking advantage of short-term reversals.

By blending these strategies, traders optimise their trading decisions and increase profitability across different market environments.

Adaptation to trading style

It is worth mentioning that traders can also adjust the settings of the super trend indicator to match their personal trading style and preferences. This can be done by fine-tuning the “period” and “multiplier” values. By making such a customisation, traders can manage risk effectively. Also, this enhances overall profitability by leading to better trading decisions. 

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

To develop a powerful trading approach, several traders combine the super trend indicator with a moving average crossover strategy. In this way, they benefit from the trend-following capabilities of the super trend and, at the same time, use moving averages to confirm trend direction. This combination provides traders with more reliable signals for entering and exiting trades. Let’s understand in detail:

1. Buy signal:

A buy signal is generated when two conditions are met simultaneously:

1. The super trend indicator changes to green, indicating a bullish trend.
   
2. The 5 EMA crosses above the 20 EMA, suggesting a short-term momentum shift to the upside.
   

2. Sell signal:

A sell signal is generated when two conditions are met simultaneously:

1. The super trend indicator changes to red, indicating a bearish trend.
2. 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.