Supertrend Indicator: Calculation, Uses & Limitations

Supertrend Indicator

The Supertrend is a widely used tool in technical analysis, designed to identify the direction of the prevailing trend. It is plotted on a price chart and shifts above or below the price based on the current regime.

How is it calculated?

This indicator relies on two key components: the Average True Range (ATR), which measures market volatility, and a multiplier that adjusts its sensitivity. The calculation involves the following steps:

Determine the Basic Upper and Lower Bands:

Upper Band (UB):

UB = (High + Low) / 2 + (Multiplier × ATR)

Lower Band (LB):

LB = (High + Low) / 2 − (Multiplier × ATR)

Calculate the Final Bands:

• Final Upper Band (FUB):
  If the price is below the current Upper Band (UB), take the lower value between the current UB and the previous FUB.
• Final Lower Band (FLB):
  If the price is above the current Lower Band (LB), take the higher value between the current LB and the previous FLB.

Plot the Indicator:

• If the price closes above the FUB, the trend is bullish, and the line is plotted below the price.
• If the price closes below the FLB, the trend is bearish, and the line is plotted above the price.

Example Calculation:

Assume the following data for a stock:

Step 1: Calculate the Basic Bands

Upper Band:

UB = (500 + 480) / 2 + (3 × 10) = ₹500

Lower Band:

LB = (500 + 480) / 2 − (3 × 10) = ₹470

Limitations

• As a trend-following indicator, it lags behind price movements and may not perform well in sideways or choppy markets.
• It helps traders identify the prevailing market trend and avoid trading against it.
• The indicator adapts to market volatility, making it effective in different market conditions.
• The effectiveness depends on the chosen multiplier and ATR period. A higher multiplier reduces sensitivity but delays signals, while a lower multiplier increases sensitivity but may lead to more false signals.