How to trade using Supertrend
Supertrend is one of the popular technical indicators every new trader looks into, perhaps because of its simplicity. I came across Supertrend when I started my trading journey. It is a trend following indicator that works best in trending markets but gives false signals during choppy or congestion phase.
This indicator does not predict the direction of the trend but indicates the direction once the trend is established. It is plotted over the price chart and it changes its colour to Green or Red, based on the price movement.
Supertrend requires only two parameters to be set, period and multiplier. The period refers to the period to be considered while calculating Average True Range (ATR). The default values used while constructing a Supertrend indicator are (10,3) i.e. 10 for period and 3 for multiplier.
Understanding ATR is important before using Supertrend. ATR is used to measure current average volatility, which is then multiplied using the multiplier value. The indicator, basically, indicates a direction when the price moves and makes a large enough move equal to or more than three times the current average volatility (3xATR).
BUY/SELL signal
Supertrend gives a clear buy/sell signal when plotted over a price chart. A buy signal is generated when the close price crosses above the Supertrend line.
Similarly, a sell signal is generated when the close price crosses beneath the Supertrend line.
Now with this, let us go ahead and create a strategy based on Supertrend.
The Strategy
Consider the following chart
It is clear from the chart that there was a trend reversal on 28th Jan and price started trending upwards. Now, let us plot Supertrend on the chart
We can see that Supertrend gave a buy signal on 28th Jan and gave a sell signal when the price retraced. Based on this information we can form a strategy: when the Supertrend line is below the close, it is time to buy. When the Supertrend line is above the close, it is time to sell.
Now that we have formed a strategy, let us backtest this on historical data. We are going to use Streak for this. Streak is a platform that enables traders to easily create, backtest and deploy their trading strategies.
We are going to put in the same logic in Streak and see how the strategy would have performed if we were to trade PFC based on signals generated by Supertrend (10,3).
Let us now backtest this idea.
With Streak, it takes only a few minutes to ideate and test your strategies. As we can observe from the backtest result, the strategy would have made a profit of 14.59% after deducting brokerage and relevant charges for a 3 month period i.e from 1st November 2019 to 29th January 2020. However, the period return is 8.95%, which means I would have made only 8.95% if I would have bought and held the stock till 29th Jan. For a buy and sell strategy, the cost is negligible. So, the strategy made 5.64% extra (alpha).
Further, we can also observe that we made profit 29 times and lost 23 times and whenever the strategy made a profit, it made an average of INR 1.46 and whenever the strategy lost, it made a loss of INR 0.91. Hence from a risk management perspective, this is perfect.
You can create such profitable strategies or check the viability of your idea easily. Just head over to www.streak.tech and sign up today.
Updated Disclosure: After finding Streak extremely useful for me personally, I have approached them and joined their team to further explore strategic trading.
