The ADX Forex Trading Strategy

Introduction to the ADX Forex Trading Strategy

The strategy that will be illustrated here combines the Parabolic SAR and the Average Directional Movement (ADX) indicator to generate the trade signals. The Parabolic Stop and Reverse Indicator will be used in the same context as its name: it will be used to detect where price stops and reverses.

Indicators Used:

To enable the stop and reverse signals to be picked out here gain greater accuracy, we will add another indicator in addition to the Parabolic SAR indicator which will be used in its default settings. The indicator to be added is the
Average Directional Movement indicator (also known as the ADX). The Average Directional Movement (ADX) has three components, but only two of these will be very relevant to the deployment of this strategy. The three components of the ADX are:

  1. The ADX line
  2. The +D1 line
  3. The – D1 line

The +D1 and –D1 components of the ADX indicator are the ADX components we will use for this strategy. The Parabolic SAR system will work on any time frame or currency pair, but the best results are obtained in currency pairs that trend very well. When attaching the indicators to the charts, the settings used are the default settings of 0.02, 0.2 for the Parabolic SAR, and the default settings for the ADX indicator.

The Strategy

The strategy is to get the Parabolic SAR to deliver a signal on whether the market will be bullish or bearish, and to get confirmation of this signal by the positioning of the +D1 and –D1 lines in the ADX indicator window. The signal plays out as follows:

Short Trade

For the short trade setup, we look for the following to occur:

  1. The Parabolic SAR indicator appears above the price action candles as dots, thus indicating a bearish bias for the trade.
  2. At the same time, we see the +DI line crossing below the -DI line.

The short trade is opened at the open of the next candlestick. The snapshot below indicates the trade setup as shown:

ADX_short

The snapshot shows the Parabolic SAR candlestick dots located above the price action candles. A grid line is traced vertically to see where there is a matching signal on the ADX indicator. We can see clearly that that the same area, the +D1 line and the –D1 line have crossed, with the +D1 line being located below the –D1 line. This is clearly a confirmation for the trader to go short on the open of the next candle.

Sometimes, you may also get an added confirmation from a candlestick formation which indicates bearishness. This is not absolutely needed to get the confirmation, but if you have it, then all the better for you.

Stop Loss

The stop loss is set at a few pips above the dots of the parabolic SAR indicator which are located above the price action candles.

Take Profit

The Take Profit is left open and the trade should be followed until an opposing signal is shown by the Parabolic SAR indicator (i.e. the indicator dots appear once more below the price action candle which is a bullish signal).

2) Long Trade

The long trade is executed using the ADX indicator’s +D1 and –D1 components as well as the dots of the Parabolic SAR. For the long trade setup, the trader should look for the following:

  1. The dots of the Parabolic SAR appear below the price action candles for the currency pair.
  2. The +DI line crosses ABOVE the -DI line in the ADX indicator window.

The snapshot below displays the trade conditions for the long trade.

ADX_long

Look at the snapshot above. The vertical grid line shows where the Parabolic SAR and the +D1/-D1 lines show a bullish signal.

Stop Loss

The stop loss is placed a few pips below the dots of the Parabolic SAR indicator when the trade entry is made.

Take Profit

The Take Profit is left open and the trade is monitored until the dots of the Parabolic SAR indicator appear on top of the candles, signifying a bearish candle signal. Some may also decide to use the +D1 line crossing the –D1 in the opposite direction to that of the entry signal. On the chart above, we can see that the candles met resistance at an area that the parabolic SAR had changed its signal to a bearish one.

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