Despite its cool name, the Supertrend indicator often seems to slip under the radar.
Here I explain how it’s calculated, and combine it with moving averages to produce a simple trend following strategy.
The complete strategy can be downloaded in the Free Strategies section.
With trend following growing in popularity, there is an abundance of trend indicators to choose from.
When I heard about the catchy Supertrend indicator, I knew I had to check it out.
What is the Supertrend Indicator?
The Supertrend is not available in MT4 by default, but you can download it here (together with the complete trend strategy illustrated in this post).
The Supertrend indicator essentially determines trend direction, and consists of a single line plotted over prices.
The market is bullish when the Supertrend is plotted below prices, and bearish when it is above prices.
The indicator flips above/below prices whenever a change in trend is detected.
Supertrend Indicator Calculations
The Supertrend measures market volatility using the average true range.
- Step 1: Calculate the average true range (ATR)
A bar’s true range is the largest of the following:
- Current high – current low
- Current high – previous close
- Current low – previous close
The ATR is then obtained by applying a 10-period rolling average to the true range in the following manner:
- Step 2: Calculate the initial upper and lower bands
These bands are offset from the average price by a multiple of the ATR. By default, a multiple of 3 is used.
- Step 3: Calculate the final upper and lower bands
Notice in the chart above that the bands always move in the same direction?
For example, when the band is below prices, the band only moves upwards or sideways, but never downwards.
The final lower band value is the larger of the current and the previous initial lower band values, calculated in step 2. If the previous initial value is larger, the band moves sideways.
Likewise, the final upper band value is the smaller of the current and previous initial upper band values. If the previous initial value is smaller, the band moves sideways.
- Step 4: Plot the final Supertrend indicator band
We have calculated the upper and lower bands, but only one band is shown on the chart each time.
If prices have closed above the final upper band, an uptrend is signalled. The final lower band should be plotted in this case.
If prices have closed below the final lower band, a downtrend is signalled. The final upper band should be plotted in this case.
I know this can be confusing, so here’s an illustration.
This is how the Supertrend flips above/below prices whenever the trend changes direction.
It reminds me of Wilder’s Parabolic SAR indicator, except that the bands do not accelerate towards prices.
How to Use the Supertrend Indicator
The easiest way to use the Supertrend is:
- Buy when prices are above the band
- Sell when prices are below the band
In a neatly trending market, such a strategy would yield great returns. The problem is that markets don’t trend that often. Most of the time, you will suffer whipsaws like those below.
The Supertrend tends to produce fewer whipsaw trades than say, a moving average crossover strategy. Nonetheless, we need a way to improve the strategy’s win rate.
A major drawback of the Supertrend indicator is that a single long candle is likely to flip the trend direction.
You may encounter an unfavourable news release, or an extended pullback in a long-term trend. These may not necessarily indicate a trend reversal; such premature market entries are best avoided.
To filter out some of these false entries, we only want to trade in the direction of the long-term trend. As the famous quote goes,
Disregarding the big swing and trying to jump in and out was fatal to me. Nobody can catch all the fluctuations. In a bull market, your game is to buy and hold until you believe that the bull market is near its end.
I’ll use a 100-period exponential moving average (EMA) to determine trend direction. This time-based average lags the market significantly, but is unlikely to be drastically affected by short-term fluctuations.
Programming the Supertrend Indicator Strategy
The Supertrend will be used together with a 100-period EMA in the manner below. The strategy will trade symmetrically on the long and short sides; only the long side is shown for brevity.
- Entry Conditions
Price closes above the Supertrend and 100-period EMA.
- Trade Execution
Place a buy stop at the previous high. Order valid for 3 bars.
- Trade Management
150-pip stop loss and trailing stop.
This was programmed in AlgoWizard:
Variables have been assigned to all parameters to allow future optimization.
Supertrend Indicator Backtest Results
I backtested the Supertrend strategy on the H1 GBPJPY, over the past 10 years.
Not too bad for a basic strategy. Out of curiosity, I removed the EMA trend filter and redid the test.
We have about 8% more trades but the performance, especially drawdown, is worse in all aspects.
The Supertrend is another trend indicator that deserves a place in your toolbox. It only contains two optimizable parameters:
- ATR lookback period
- ATR multiplier
Both parameters control the offset between the Supertrend and prices. I recommend optimizing only one of them.
To avoid false entries, I suggest complementing the Supertrend with time-based trend detection such as moving averages.
Or if you want to use the Supertrend for trade exits, I believe it would serve well as a trailing stop, much like Wilder’s Parabolic SAR.
The complete strategy described above can be downloaded in the Free Strategies section.
Have you found success with the Supertrend indicator? Let me know in the comments!