One of the more popular forms of trading is called “trend trading”. This is where you define the dominate price trend and trade in that direction.
Trend following was made popular by the Turtle Traders and although buy and hold has lost its popularity, trend following is still very popular.
Using the Supertrend indicator as part of a trend following system, we are going to be able to make our trading 90% mechanical which will help leave all biases and “gut feelings” out of the trading equation.
The great thing is that your trading is not based on forecasting. Trend following is a reactive form of trading because in the end, the only truth is the price.
Forecasts are meaningless.
“Let’s break down the term trend following into its components. The first part is trend. Every trader needs a trend to make money. If you think about it, no matter what the technique, if there is not a trend after you buy, then you will not be able to sell at higher prices – following’is the next part of the term. We use this word because trend followers always wait for the trend to shift first, then follow it.” – Van Tharp
The Supertrend trading system seeks to capitalize on the long term trend using shorter term trends to get on board for the price move.
Supertrend Trading System Indicators And Settings
We will use 3 indicators for this supertrend strategy however one of them is help determine our stop loss placement on the trade.
- Supertrend Indicator – Settings of period 8 and multiplier of 1.5
- Simple Moving Average – 200 period
- ATR – This measures volatility and we will use 14 periods and 1.5 X for risk
- Time Frame – 4 hour and up
- Currency Pair – Any
The actual supertrend indicator will be used for:
- Green will be for a buy signal
- Red will be for a sell signal
Our 200 period moving average is the longer term trend direction.
- If price is above the moving average, we look to buy when supertrend turns green
- If price is below the average, we look to sell the red supertrend signal
We are using the Average True Range indicator to determine our stop loss. For example, if the ATR reading for the EURUSD is 100 pips, we will use 1.5 X 100 to get a pip stop location at 150 pips below or above our trade entry.
Supertrend Trading System Explained
This Forex trading system is simple in execution but can be very difficult depending on your ability to manage risk and losing trades.
We have applied the moving average and Supertrend indicator on this daily chart of the EURJPY. Let’s walk through the labelled section of the chart for a sell position.
- 200 SMA is sideways and price is whipsawing back and forth over the line. We also have rapid changes in the supertrend from red-green-red-green. We would want to stand aside from trading especially is you are a conservative trader
- This highlights the downtrend and we can see the moving average has turned over and price is fully under the average. We are only looking for shorts.
- Here we have the first green to red since the downtrend has been confirmed. We short at the close of the candlestick the turned the indicator to red.
- This is one exit we can use and it’s when price breaches and closes above the 200 day moving average
Here are some number for this trading setup:
- Entry was at the close: 131.57
- Stop was based on ATR of 1.2026 X 1.5 = 1.8039 + 131.57 = 133.37
- Exit was at confirmed candlestick close over 200 SMA 118.79
- Pip total = 1278 or 7R (7 times what was risked)
All trades will not play out like this and there will times when you are trading in choppy market conditions long before price registers whipsaws along the 200 SMA.
Multiple Time Frame Trading With Supertrend
We can make this trading strategy even simpler by using the supertrend indicator on two time frames. For a daily trading chart, we can use the supertrend trend determination on the weekly.
This is the daily GBPUSD chart and the green line indicates that the weekly trend is up according to the supertrend indicator that turned where the green line is.
This daily chart has already turned green before the previous week closed that gave us the signals for long trades only.
The yellow line indicates a potential resistance point that is in place before the weekly trend is up. We can look to get in sync with the chart condition and take a long trade when price breaks the resistance area on close.
The issue now is that entry candle is huge and while you can make a rule in regards to large candlesticks, for this example we will keep in line with the rules.
- Entry price is 1.2821
- ATR is 1.2821 – (91 pips x 1.5) = 1.2684 stop price
This trade is stopped out on the extreme retrace that pulls back for a test of resistance (potential support) for a 137 pip loss.
We can re-enter when supertrend turns green at 1.2817. Our stop using the 1.5x ATR method is at 1.2686. The trade is currently in profit of 167 pips from a peak profit point of 450 pips
DISADVANTAGES OF THE SUPERTREND TRADING STRATEGY
You can see one of the main disadvantage of the Supertrend strategy on the last chart. The pullback in price has seen a few hundred pips disappear. Not many traders can stand seeing profits evaporate like that.
That’s always been one of the kicks against trend following and that is you will sit through extreme pullbacks, even go into draw down and never see the trade recover.
You MUST have strong risk management skills or you will quickly eat your account into zero.
These trades can run a long time and you may be tempted to exit the trade due to:
Greed – Seeing all the pips accumulate and how many things the winnings can buy
Fear – Seeing all the profits disappear
All that said, there is one huge reason why you’d want to trade something like this Forex system
ADVANTAGES OF THE SUPERTREND FOREX TRADING STRATEGY
The trend is confirmed and you enter what may become a trend that lasts weeks, months, or even years.
This trade in the USDJPY ran for 311 days and booked 1785 pips with an initial risk of 74 pips giving you an R multiple of 24. Hope you can see the massive potential in this trading strategy.
Remember we used the setting of 8 and 1.5 for supertrend? We never changed those inputs when using the multiple time frame approach.
If we used the default settings of 10,3, and kept the trading chart at 8, 1.5, this same trade gave up 3847 pips!
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