Supertrend is a commonly used indicator that is particularly effective in Indian markets. It was invented by Olivier Seban. It was designed for futures, forex, and equities but really works for any commodity. It has an unusually high accuracy of around 70- 80%. It is one of the few indicators that can be used in standalone technical analysis as it notifies the trader of an entry position and an exit position while also keeping track of a trailing stop loss. It is an indicator that relatively closely hugs the price curve of the stock.
Another important reason why the super trend is very famous among traders is for the fact that it has very good Risk-Reward ratio.
Usually, when a stock goes against us super-trend gives us exit signals minimizing our losses and if trend goes in our favour super-trend continues maximising our gains.That way our gains are automatically greater than losses.
Making the Risk-reward ratio greater than 1:2
How to generate Entry and Exit signals using Super-trend
Since super-trend dynamically adjusts itself with price, so it will work on all time frames.
Be it 1min or 1-day candle.
Below is the graph of supertrend on a Random script plotted on 15min time-frame.
As can be seen from the image above, the supertrend indicator follows the price curve and gives appropriate buy and sell signals while maintaining a rigid stop loss. It indicates the change in trend by flipping above and below the price curve, this is also expressed by the changing colors of the indicator line.
When the indicator value flips above the price curve it generates a sell signal. Whereas when the indicator flips below, it will generate a buy signal.
The indicator itself has two parameters a multiplier factor and an ATR period; appropriate values must be chosen for the indicator to be reliable. The default values are 10 for the ATR period and 3 as the multiplier. They must be tuned as per the required strategy.
To first understand how the super trend line is plotted, we have to talk about another indicator the Average True Range(ATR).
Average True Range
The average true range is a commonly used indicator in technical analysis that measures the market volatility of a particular asset. It was introduced by market technician J. Welles Wilder Jr.
To mathematically understand ATR let us first define True Range. The true Range gives us a brief idea regarding the dispersion or volatility in the price at a given moment.
The true range is the maximum of
(i) the difference between the current high and the current low
(ii) the absolute difference between the current high and the previous close
(iii) the absolute difference between the previous close and the current low
Hence, the average true range will be the true range averaged over a period of time, usually 14 or 15 days (since that roughly translates to 3 weeks of market data). As can be seen below higher values of ATR indicate large fluctuations in price hence reflecting volatility.
TR= max [(high−low), abs(high−closeprevious), abs(low−closeprevious)]
Similarly the supertrend is plotted as,
Up = (high + low)2+ multiplierATR
Down = (high + low)2– multiplierATR
By optimizing the parameters of the supertrend and using it along with other indicators such as MCA and RSI it can be invaluable for a trader depending on their particular strategy since it covers both buy and sell signals while also protecting the investment with a trailing stop loss.
Multi-time frame supertrend trading strategy
By simply using 3 super trend lines in tandem with each other we can create an astonishingly accurate strategy by adjusting the parameters for each trendline.
Using another supertrend indicator as the stop loss only enhances the effectiveness of this strategy.
By setting the parameters as follows;
we get 3 trendline indicators for our buy-sell triggers and a 4th which corresponds to the stop loss. This strategy is effective because of the different periods and factors of the numbered indicators analyze trends over different periods in different capacities. The order whether it be buying or selling is only executed when all three indicators agree on the changing trend, so it proves to be a lot more accurate than just a single indicator or even different ones used alongside each other.
The working of the
Multi supertrend plotted like this :
There are 4 super-trend.
3 to confirm the trend and 1 to act as SL.
When all three give buy/sell together only then the trade will be triggered.
SL will be 4th supertrend.
Target is as per reversal of the trend.
The same strategy can also be automated using Multi-super trend AFL.