Supertrend Indicator: What is it, and how does it work?

The first brief answer to the question ‘What is the Supertrend indicator?’ is that it is a trend-following signal, i.e., helpful in identifying and following an ongoing price movement. 

It is one of the most popular in the trading world mainly because it is very easy to use. The Supertrend indicator is also remarkably efficient because it analyses volatility along with price movements.

Let us analyse this indicator in detail to understand what the Supertrend is and how it works.

Supertrend Indicator: What is it?

Olivier Seban, a professional trader, writer, and teacher, invented the Supertrend in 2011. It belongs to the family of trend-following indicators. These compare price movement information to try to identify the direction of a trend. They are also useful for understanding when the current trend reverses.

How does it do this? It calculates the average candlestick price on the reference timeframe and the volatility of a stock, cryptocurrency, commodity, or index.

To understand what the Supertrend is, we need to know what it looks like on the chart. This indicator consists of a line that changes colour, usually from green to red, and position, depending on the movement of the asset in question. 

For example, if it is bearish, the Supertrend indicator will stand above the price as a kind of resistance. Conversely, if the market is rising, the line will support the candles, acting as support.

Supertrend Indicator: How it works

After understanding the Supertrend indicator, it is time to analyse how it works. The first step is to understand how to set it. There are two main components: the number of bars or length and the factor or multiplier.

This parameter determines the number of bars or periods used to calculate the Average True Range (ATR), a key component of the Supertrend. The ATR measures market volatility based on the price range of each bar or period. The ‘Number of Bars’ affects the sensitivity of the ATR and, consequently, the Supertrend itself. 

A larger number of bars produces a ‘flatter’ ATR and, consequently, a Supertrend less responsive to price changes, making it more stable in times of volatility. Conversely, fewer bars make the ATR (and thus the Supertrend) more responsive to price movements.

Instead, this parameter is multiplied by the ATR and used to adjust the distance of the Supertrend line from prices. Increasing the value of the Factor widens the bands of the Supertrend, making it less sensitive to price movements and reducing false signals in periods of volatility.

How it is calculated and the formula

As mentioned, the Supertrend indicator is based on the Average True Range (ATR), one of the fundamental measures for calculating price volatility. Introduced by J. Welles Wilder Jr. in his book ‘New Concepts in Technical Trading Systems’, the ATR provides a detailed overview of asset price fluctuations. For this reason, it is one of the most frequently found tools in traders’ toolboxes.The basic concept behind the ATR is quite simple: the range of movements of an asset, thus providing an estimate of the volatility of that period. This measurement is done by decomposing the entire price range of the asset. The calculation of the ATR considers the deviation between the point of maximum and the point of minimum; it is the absolute value of the difference between the point of minimum or maximum and the point on the graph where the range is closed.

But let us now see what the Supertrend indicator is in detail by analysing the information it uses to produce the line from which it is composed:

The Supertrend indicator then compares the three distances between these values and uses only the largest one, which is known as the actual range, for further calculations.

After analysing all the variables that make it up, we are ready to tackle the formula that the Supertrend indicator uses to calculate the trend line.

Supertrend = (Maximum point + Minimum point) / 2 + (Multiplier or Factor * ATR)

Once the volatility bands have been calculated, the indicator determines whether the asset price is bullish or bearish. It places the corresponding band above or below the price. If the price crosses one of the bands, the indicator signals a possible trend change.

Supertrend indicator: advantages and disadvantages

As already mentioned, many traders and investors use the Supertrend indicator to make more informed decisions and limit risk. What are its strengths, and at what junctures is it better to prefer other indicators?

Conclusions

In conclusion, now you know what the Supertrend indicator is: a versatile and widely adopted technical analysis tool ideal for traders seeking to identify an asset’s trend. Its ease of use, combined with its ability to provide clear indications of dynamic support and resistance levels, makes it invaluable for anyone trading in the markets, regardless of level or experience.

However, as with any analysis tool, the Supertrend also has weaknesses. Its nature as a lagging indicator requires traders to be cautious and combine it with other technical analysis methodologies to confirm trading signals and reduce the possibility of false alarms. In addition, traders should be aware of the market risks associated with using the Supertrend in shorter time frames and sharply sideways markets.

You can access Young Platform Pro and test it by analysing the price action of many cryptocurrencies. Using our app, you can also activate a Smart Trades strategy that automatically executes trades based on this indicator.