Supertrend Indicator Strategy

Supertrend Indicator Strategy – (11.07% profit/trade!) | Backtested

In this article, we will discuss an indicator called SuperTrend, which has a very promising name. So, what is the Supertrend Indicator Trading Strategy exactly?

The SuperTrend indicator is a type of trend following indicator that was created by trader Oliver Seban. It signals the direction of a trend, its continuation, or changes in direction. Our backtest reveals that the indicator can catch most of the returns while avoiding the worst drawdowns, thus giving acceptable risk-adjusted returns.

In the rest of this article, we will test its effectiveness and explain how it works. Let’s start by explaining the indicator:

What is the Supertrend Strategy?

Supertrend Indicator - Riding Market Trends

The Supertrend Indicator is a trend indicator that is meant for long-term investments by “riding the trend”.

Oliver Seban has given us a great tool for highlighting how an instrument’s price moves. However, as we will see, the SuperTrend Indicator is useful for chartists and those who want to do algorithmic trading.

The SuperTrend indicator appears as a line superimposed on the price chart. If the price increases, it will be above the Supertrend indicator, which will be green. Vice versa, if the price is decreasing, it will be below the indicator, which will be red.

If the price of a bar closes by crossing the previous period’s SuperTrend indicator value, the SuperTrend indicator will reverse direction, indicating a trend change. We observe this feature in the image:

Supertrend Indicator example
Supertrend Indicator example

In the chart above, the close of the candle at 4397.94 determines the inversion of the Supertrend indicator because this value is lower than the value of 4401.58203 that the indicator had in the previous period.

Another important feature that we can see in the image above is that the Supertrend indicator is always increasing when it is below the closing price and always decreasing when it is above it.

We can therefore say that the Supertrend indicator alternates between two phases: a phase in which it is increasing, signaling an upward trend, and a phase in which it is decreasing, indicating a downward trend.

Supertrend Indicator Strategy – Backtest and Calculation

Let’s backtest the Supertrend Indicator Trading Strategy over a long period of time.

The instrument we will backtest is the S&P500 index over the last 60 years. Given the long-term rising trend of the index, it makes sense only to go long.

The time frame is weekly, and we use the default parameters of the Supertrend indicator originally proposed by the inventor Oliver Seban: 10 for the calculation of the ATR and 3 (for the band). We reinvest all capital without considering commission and slippage, not including reinvested dividends.

Our backtest returned the following equity curve:

Supertrend indicator strategy success rate
Supertrend indicator trading strategy backtest

It looks great. But let’s analyze the trading statistics and performance metrics.

  • 38 trades since 1960
  • Annual Return: 5.92% (buy and hold is 6.91%) – not including dividends
  • Average gain per trade is 11.07%
  • success rate: 65.79% of the trades are winners
  • You are invested 62.67% of the time
  • Max drawdown is 24.6% (buy and hold 56.24%)
  • Risk-adjusted return is 9.44% (5.92% divided by 0.6267) (buy and hold 6.91%)

The probability of entering a winning trade is 65.79%. A high win rate is good to get confidence in the trading system.

Accuracy of the supertrend indicator

The risk-adjusted return summarizes the strategy’s accuracy because it considers how much you get from the market compared to how long you stay in the market. For the buy & hold strategy, this value coincides with the Annual Return because the denominator, in this case, is equal to 1 (you are invested in the market 100% of the time). The accuracy of the Supertrend indicator is also confirmed by the “small” max drawdown of 24.6%, which is less than half of the buy & hold (56.24%).

Here is the complete trade list with all 38 trades:

Supertrend Indicator Strategy accuracy and performance

We end the backtest by showing the complete list of the annual returns:

Supertrend Indicator Trading Strategy annual returns

How accurate is the Supertrend indicator?

The accuracy of the Supertrend indicator is around 67% from our calculation and tests.. You can see a historical backtest above in the article.

At this point, we might ask ourselves: How accurate is the Supertrend Indicator Trading Strategy?

The answer cannot ignore the objective for which the Supertrend indicator was invented: To highlight trends, as its name implies. As we will see later in our backtest, the Supertrend indicator can be a very accurate tool as long as it is applied to financial instruments that tend to maintain a direction in the price. So it may not be suitable for analyzing any random financial instrument.

What is the win rate of the Supertrend strategy?

The win rate of the Supertrend indicator is around 67% from our calculation and tests. The win rate of the Supertrend strategy also may varies depending on several factors such as market conditions, asset class traded, timeframe, and specific parameters used in the strategy. Generally, the win rate of the Supertrend strategy is influenced by its ability to capture trending movements in the market. However, it’s essential to backtest the strategy thoroughly across different market conditions and timeframes to get a more accurate estimation of its win rate.

What is the success rate of the Supertrend strategy?

According to our calculations and tests, the Supertrend indicator demonstrates a success rate of approximately 67%. However, the win rate of the Supertrend strategy can fluctuate due to various factors including market conditions, traded asset class, timeframe, and specific strategy parameters. Typically, the effectiveness of the Supertrend strategy in capturing market trends significantly impacts its win rate. Nonetheless, it’s crucial to conduct comprehensive backtesting across diverse market conditions and timeframes to obtain a more precise assessment of its win rate.

What are the different Super Trend Indicators?

There are several variations of the Super Trend Indicator, each with its own calculation method and parameters. Some of the most commonly used Super Trend Indicators include:

  1. Standard Super Trend Indicator: This version calculates the trend direction based on the average true range (ATR) and the moving average of price. It generates buy signals when the price closes above the indicator line and sell signals when the price closes below it.
  2. Modified Super Trend Indicator: This version adjusts the calculation method of the standard Super Trend to provide more timely signals or to better suit specific trading styles or market conditions.
  3. Adaptive Super Trend Indicator: Unlike the fixed parameters in standard and modified versions, the adaptive Super Trend adjusts its parameters dynamically based on market volatility or other customizable criteria. This adaptability can help improve the indicator’s performance across different market conditions.
  4. Double Super Trend Indicator: This variation uses two Super Trend lines, typically with different parameters, to provide additional confirmation of trends or to generate more conservative entry and exit signals.
  5. Color-Coded Super Trend Indicator: Instead of displaying buy and sell signals with arrows or lines, this version of the Super Trend Indicator uses color changes in the indicator line to indicate trend shifts, making it easier for traders to visually identify trend changes.
  6. Multi-Timeframe Super Trend Indicator: This version allows traders to overlay Super Trend signals from different timeframes onto a single chart, providing a broader perspective on market trends and potentially enhancing signal reliability.

Which time frame is best for the Supertrend Indicator?

The best time frame for the Supertrend indicator is the weekly time frame. But it can be applied intraday, daily, or weekly charts. But in order to allow the Supertrend indicator to be accurate and do its job well, it is essential to choose a time frame in which the financial instrument is in a trend for long periods.

Which time frame is the most suitable for you can only be found out by backtesting. Later, in our backtest, we use a weekly time frame, and you’ll discover that the Supertrend indicator works well for stocks in that time frame.

How to avoid false signals with the supertrend indicator?

Every quantitative trader aims to improve the historical performance of his trading system. To do this, he or she can optimize by using different inputs into the parameters while (hopefully) avoiding overfitting and curve fitting.

If the historical performance improves, it is possible to avoid false signals that would have generated unprofitable trades. How can we achieve this with the Supertrend Indicator? The indicator has two input parameters that must be established to avoid false signals.

What is the Supertrend indicator formula?

The Supertrend indicator formula is based on the median price of a candle – calculated like this:

MedianPrice = ( H + L ) / 2;

….and on the very famous volatility indicator called Average True Range indicator presented by Welles Wilder in the 1970s, in his famous book called New Concepts in Technical Trading Systems, published in 1978. If you want to know more about ATR, please read Average True Range Trading Strategy (ATR Indicator and System – How To Use It).

The formula of the Supertrend Indicator uses the median price and the ATR to construct the two bands of a channel as follows:

UpBand = MedianPrice + Multiplier * ATR( Periods );

DnBand = MedianPrice – Multiplier * ATR( Periods );

We have thus two inputs into the formula:

  • The number of bars in which to calculate the ATR, and
  • The multiplier – the coefficient which establishes the ATR above and below the median price.

Oliver Seban proposed using the Supertrend indicator with periods of 10 and a multiplier of 3.

A question arises around Supertrend indicator formula: if there are two bands and, therefore, there is a channel in which the price moves, how is it possible that the Supertrend indicator appears as a single line?

To understand what happens “behind the scenes”, please observe the following image which shows both the bands and the single line indicator:

Supertrend Indicator Trading Strategy example

The Supertrend indicator takes on the values of both the lower and upper bands alternatively, but with the condition that the lower band cannot decrease and the upper band cannot increase. If this happens, the Supertrend indicator takes on the value of the relative band of the previous period. When the closing price of a candle crosses the value of the Supertrend indicator from the previous period, the indicator begins to follow the opposite band, leading to a reversal in trend.

What are the trading rules for the Supertrend Indicator?

The trading rules of the Supertrend Indicator are as follows. We will backtest these to make sure they are good settings. We set ourselves the goal of capturing the upswings of the stock market while minimizing the downturns. With this intention, the rules are:

Trading Rules

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In the image below you can see a trade example following the rules stated above:

Supertrend indicator trading strategy rules

The buy signal was triggered on 05/29/2020 at 3044.31, and the sell signal is triggered on 01/21/2022 at 4397.94, resulting in a gain of 1353.63 points which equals a profit of 44.46%.

How to Calculate Super Trend Indicators?

To calculate the Super Trend indicator, you first need to determine the Average True Range (ATR) over a specified period, typically 7 or 14 days. Then, you calculate the Upper Band and Lower Band based on a multiplier of the ATR. The Upper Band is calculated by adding the multiplier multiplied by the ATR to the previous period’s closing price, while the Lower Band is calculated by subtracting the same product from the previous closing price. Finally, you use these bands to determine whether to generate a buy or sell signal based on whether the current price is above or below the bands, respectively.

What are the supertrend indicator best settings?

Here are the best settings typically used for the Supertrend Indicator:

Length: This refers to the number of periods used to calculate the moving average. It determines how responsive the indicator is to price changes. Common lengths include 7, 10, 14, or 20 periods, but it can vary based on trader preference and the timeframe being analyzed.

Multiplier: This parameter determines the sensitivity of the indicator to price changes. It is usually set between 1 and 3, with higher values resulting in a tighter band around the price and lower values allowing for more volatility. A common multiplier value is 2.

However, we prefer to use the settings from our backtest and trading rules above.

Is SuperTrend a good indicator?

Yes, the SuperTrend is a good indicator according to our backtest and analysis.

What are the Benefits of Super Trend Indicators?

The benefits of Super Trend indicators include their ability to provide clear trend direction, offering straightforward entry and exit signals for traders, and helping to filter out market noise for more reliable trading decisions.

How does Super Trend differ from other Indicators?

Super Trend differs from other indicators in that it combines elements of trend-following and momentum indicators to identify trend direction and potential reversals. It uses a combination of price action and volatility to generate signals, making it unique compared to traditional indicators like moving averages or oscillators.

Does the RSI work well in conjunction with the Super Trend Indicator?

Yes, the RSI (Relative Strength Index) can work well in conjunction with the Super Trend Indicator, providing complementary insights into market momentum and potential trend reversals.

Does the Moving Average work well in conjunction with the Super Trend Indicator?

Yes, the Moving Average can work well in conjunction with the Super Trend Indicator, as it can provide additional confirmation or signal when used together.

Is Supertrend indicator leading or lagging?

The Supertrend indicator is considered a lagging indicator. It derives its signals from historical price data and provides insight into the trend’s direction after it has already begun. Therefore, it tends to follow the price movement rather than predict it in real-time.

What are the Limitations of the Super Trend Indicator?

The Super Trend Indicator, like any technical analysis tool, has its limitations. Here are some common ones:

  1. Lagging Indicator: The Super Trend Indicator is a lagging indicator, meaning it reacts to price movements after they have occurred. This can result in delayed signals, which may cause traders to enter or exit trades late.
  2. Whipsaws: In choppy or sideways markets, the Super Trend Indicator can produce false signals, leading to whipsaws. Traders may end up entering and exiting trades frequently, resulting in losses due to transaction costs and slippage.
  3. Trend Identification Issues: While the Super Trend Indicator is designed to identify trends, it may struggle to accurately distinguish between trending and ranging markets. During ranging markets, it may generate false signals, leading to losses for traders who rely solely on its signals.
  4. Parameter Sensitivity: The effectiveness of the Super Trend Indicator can depend on the parameters chosen, such as the period length and multiplier. Different market conditions may require different parameter values, and finding the optimal settings can be challenging.
  5. Noisy Price Data: The Super Trend Indicator may produce erratic signals in the presence of noisy price data, which can be common in certain markets or during periods of high volatility. Traders need to filter out such noise to avoid false signals.
  6. Not Suitable for All Market Conditions: The Super Trend Indicator may perform well in trending markets but may struggle in choppy or highly volatile conditions. Traders need to be aware of its limitations and consider using additional tools or techniques to complement its signals.
  7. No Guarantee of Accuracy: Like any technical indicator, the Super Trend Indicator is not foolproof and may produce incorrect signals from time to time. Traders should use it as part of a comprehensive trading strategy and not rely solely on its signals for decision-making.

Can Bollinger Bands be used with Super Trend Indicators to improve trading strategy?

Yes, Bollinger Bands with Super Trend Indicators can be used to enhance a trading strategy. Bollinger Bands are a volatility indicator consisting of a middle band (usually a simple moving average) and two outer bands that represent the standard deviation of price movement. On the other hand, Super Trend Indicators provide insights into the direction of the trend.

By integrating these two indicators, traders can potentially improve their strategy in several ways:

  1. Confirmation of Trends: When the Super Trend Indicator signals a trend direction (e.g., uptrend or downtrend), Bollinger Bands can be used to confirm the strength of that trend. If the price remains consistently outside the Bollinger Bands in the direction indicated by the Super Trend, it reinforces the validity of the trend.
  2. Identification of Reversals: Bollinger Bands can help identify potential reversal points. When the price touches or crosses the outer bands of the Bollinger Bands after a significant move indicated by the Super Trend Indicator, it could signal an overextension of price and a possible reversal in the opposite direction.
  3. Volatility Assessment: Bollinger Bands offer insights into market volatility. When the bands contract, it suggests low volatility, whereas widening bands indicate increasing volatility. By considering volatility alongside trend direction indicated by the Super Trend, traders can adjust their risk management and position sizing accordingly.
  4. Entry and Exit Points: Combining the signals from both indicators can provide clearer entry and exit points. For instance, entering a trade when the price breaks out of the Bollinger Bands in the direction indicated by the Super Trend can offer a strong confirmation signal.
  5. Filtering False Signals: Utilizing both indicators can help filter out false signals. If a potential trend reversal signaled by the Super Trend Indicator occurs within the normal range of Bollinger Bands, it might be considered less reliable compared to a reversal occurring outside the bands.

How does the Super Trend Indicator work?

The Super Trend Indicator works by analyzing the underlying trend in a financial asset’s price movements. It’s a technical analysis tool commonly used by traders to identify the direction of the trend and potential entry and exit points in the market. The indicator is based on two main components: the Average True Range (ATR) and a multiplier value.

First, the Average True Range (ATR) is calculated, which measures the volatility of the asset over a specified period. Then, the ATR is multiplied by a predetermined factor (usually between 1 and 3) to create an offset value. This offset value is then added or subtracted from the asset’s price, depending on whether the trend is bullish or bearish, respectively.

The resulting line is the Super Trend line, which moves with the price action but lags behind during strong trends. When the price is above the Super Trend line, it suggests a bullish trend, and when it’s below, it indicates a bearish trend. Traders often use the crossover of the price and the Super Trend line as potential entry or exit signals, depending on their trading strategy. Additionally, the distance between the price and the Super Trend line can provide insight into the strength of the trend.

Why is the Super Trend Indicator important in Technical Analysis?

The Super Trend Indicator holds significance in Technical Analysis for several reasons. It serves as a valuable tool for traders and analysts alike due to its ability to provide clear signals of trend direction and potential entry or exit points in the market. This indicator is particularly useful because it combines both trend-following and momentum-based principles, offering a comprehensive view of market dynamics.

One of the primary reasons the Super Trend Indicator is important is its simplicity and ease of interpretation. Traders can quickly grasp its signals, which are typically represented by color changes or specific thresholds, making it accessible to both novice and experienced traders. This simplicity reduces the likelihood of misinterpretation and allows traders to make informed decisions efficiently.

Additionally, the Super Trend Indicator helps traders identify trends in the market, whether they are bullish or bearish. By doing so, it assists in filtering out noise and focusing on significant price movements, thereby enhancing the accuracy of trading strategies. This is crucial for traders seeking to capitalize on trends and avoid getting caught in choppy or sideways markets.

Furthermore, the Super Trend Indicator aids traders in setting stop-loss levels and trailing stops, thus managing risk effectively. By dynamically adjusting these levels based on the prevailing trend, traders can protect their profits and minimize potential losses. This risk management aspect is essential for maintaining consistency and longevity in trading endeavors.

Can Supertrend be used effectively in ranging markets?

Yes, the Supertrend indicator can be utilized effectively in ranging markets. Ranging markets are characterized by price movements within a defined range or sideways movement without a clear trend. While Supertrend is primarily known for identifying trends and capturing trend-following opportunities, it can also be adapted to suit ranging market conditions.

In a ranging market, the Supertrend indicator can be used to identify potential reversal points or to generate signals for trading within the range boundaries. Traders can adjust the parameters of the Supertrend indicator to suit the specific characteristics of the ranging market, such as shortening the look-back period or tightening the volatility multiplier.

When using Supertrend in a ranging market, traders should focus on the crossover of price and the Supertrend line, as well as the behavior of price around the Supertrend line. For example, in a sideways market, price may repeatedly touch or bounce off the Supertrend line without establishing a clear trend direction. Traders can use this information to enter trades at range extremes or to trade within the range by buying near support and selling near resistance.

Additionally, incorporating other technical indicators or price action analysis can enhance the effectiveness of Supertrend in ranging markets. Traders may use oscillators like the Relative Strength Index (RSI) or the Stochastic Oscillator to confirm signals generated by the Supertrend indicator or to identify overbought and oversold conditions within the range.

How does Supertrend adjust to changing market volatility?

Supertrend adjusts to changing market volatility by dynamically responding to fluctuations in price movements. This is achieved through its adaptive nature, which recalibrates its parameters based on current market conditions. When volatility increases, Supertrend widens the distance between its trend line and the price action, providing a buffer against rapid price swings. Conversely, in periods of lower volatility, the Supertrend tightens, reflecting a closer relationship between the trend line and the price movement. This ability to adapt allows Supertrend to remain relevant and effective across various market environments, helping traders make informed decisions regardless of changing conditions.

How does Supertrend compare to other trend-following indicators?

Similar to other trend-following indicators, Supertrend is designed to identify the direction of a prevailing trend in a financial market. However, what sets Supertrend apart is its unique methodology and calculation formula. While indicators like Moving Averages (MA), Moving Average Convergence Divergence (MACD), and Relative Strength Index (RSI) rely on specific mathematical calculations based on historical price data, Supertrend combines elements of volatility and price action to generate its signals.

One key advantage of Supertrend is its ability to dynamically adjust to changing market conditions, reflecting shifts in volatility levels. This feature makes it particularly useful in capturing trends in both volatile and ranging markets. Additionally, Supertrend provides clear buy and sell signals, making it easier for traders to interpret and act upon.

However, like any other indicator, Supertrend is not immune to false signals or whipsaws, especially during periods of high market volatility or choppy price action. Traders often use additional confirmation tools or incorporate risk management strategies to mitigate the impact of false signals.

Is Supertrend suitable for intraday trading strategies?

Yes, Supertrend can be suitable for intraday trading strategies due to its ability to identify trends and provide potential entry and exit points within a short timeframe. The Supertrend indicator is widely used by intraday traders to capture short-term price movements and capitalize on momentum. By generating buy and sell signals based on the prevailing trend, it helps traders make informed decisions about when to enter or exit positions during the trading day. However, like any trading strategy, it’s essential for intraday traders to combine Supertrend with other technical analysis tools and risk management techniques to enhance its effectiveness and minimize potential losses.

Supertrend Indicator Glossary

  1. Trend Analysis – Evaluating the direction in which a market or asset’s price is moving.
  2. Average True Range (ATR) – A measure of market volatility by decomposing the entire range of an asset price for that period.
  3. Volatility – Indicates the degree of variation of a trading price series over time.
  4. Price Action – The movement of securities’ prices and is the basis for chart-based trading strategies.
  5. Bullish and Bearish Signals – Indicators suggesting the future upward (bullish) or downward (bearish) movement of an asset price.
  6. Technical Analysis – The study of past market data, primarily price and volume, to forecast future price movements.
  7. Moving Averages – Indicators that smooth out price data by creating a constantly updated average price.
  8. Momentum Indicators – Tools used to measure the speed or velocity of price changes in a stock or asset.
  9. Stop Loss Orders – An order placed with a broker to buy or sell once the stock reaches a certain price, designed to limit an investor’s loss on a security position.
  10. Trailing Stops – A type of stop loss order that moves with the market price and is designed to protect gains by enabling a trade to remain open and continue to profit as long as the price is moving in the investor’s favor.
  11. Market Sentiment – The overall attitude of investors toward a particular security or financial market.
  12. Trading Volume – The amount of an asset or security that changes hands over a set period of time.
  13. Price Oscillators – Technical analysis tools that show the difference between a fast and slow moving average to identify potential market trends.
  14. Chart Patterns – Distinctive patterns formed by the movement of securities’ prices on a chart and are used as indicators of future price movements.
  15. Support and Resistance Levels – Price levels on charts that indicate where prices are likely to reverse direction.
  16. Financial Markets – Platforms that facilitate the buying, selling, and trading of financial assets like stocks, bonds, and currencies.
  17. Risk Management – The process of identification, analysis, and acceptance or mitigation of uncertainty in investment decisions.
  18. Trading Strategies – A fixed plan designed to achieve a profitable return by going long or short in markets.
  19. Market Trends – The general direction in which a market or the price of an asset is moving.
  20. Backtesting – The process of testing a trading strategy on historical data to see how it would have performed.
  21. Candlestick Charts – A style of financial chart used to describe price movements of a security, derivative, or currency.
  22. Breakouts and Breakdowns – Terms referring to the upward (breakout) or downward (breakdown) movement of a price through an identified level of support or resistance.
  23. Leverage and Margin – Financial techniques that increase the potential return of an investment by allowing traders to borrow money to increase their position size.
  24. Market Liquidity – A market’s feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset’s price.
  25. Portfolio Diversification – An investment strategy that spreads risk by allocating investments among various financial instruments, industries, or other categories.
  26. Behavioral Finance – A field of finance that proposes psychology-based theories to explain stock market anomalies.
  27. Algorithmic Trading – The use of computer algorithms to automatically make trading decisions, submit orders, and manage those orders after submission.
  28. Market Efficiency – The degree to which stock prices reflect all available, relevant information.
  29. Financial Instruments – Assets that can be traded, or they can also be seen as packages of capital that may be traded.
  30. Economic Indicators – Statistics about economic activities that allow analysis of economic performance and predictions of future performance.

Conclusions

At the end of this article, we would like to express our opinion based on the statistical analysis of historical performance. We believe the Supertrend Indicator Trading Strategy is highly accurate in enabling you to track market upswings while avoiding downswings. Moreover, it is worth noting that the Supertrend indicator was developed in the 90s; therefore, around 40 years of performance are out-of-sample.

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