All Forex traders strive to build their own profitable strategies. Well, this day is your lucky day! We’re willing to share the best ADX strategy with you, which was built by a professional trader. Our team at Trading Strategy Guides firmly believes the easiest way to become a profitable trader is to mimic the behavior of professional traders.
We have talked a lot about trend trading strategies. You can find plenty of evidence here: MACD Trend Following Strategy- Simple to learn Trading Strategy, here: How to Profit from Trading Pullbacks and here: Swing Trading Strategies that Work.
However, we haven't covered how to measure the strength of the trend in any possible time frame. You can only measure the strength of the trend by using a special trading indicator. For example, the ADX, which is an acronym for Average Directional Index.
Detecting a strong directional move is the most important skill for all traders to have. No matter what type of trader you are, after you enter a position you need a strong directional move. In order to make a profit, the move must be in the direction of your trade.
The ADX indicator trading rules can help you achieve your financial goals.
Before moving forward, we must define which technical indicator we need for the best ADX strategy. We will define the rules of ADX indicator trading. Also, read the hidden secrets of moving average, for more information.
ADX Indicators for Futures
The principles of the Average Directional Index can apply to almost all tradable assets including stocks, exchange-traded funds, mutual funds, and futures contracts. ADX has become exceptionally useful in futures markets for many reasons:
- With a standard range of 14 bars, ADX offers a “bigger picture” than many other technical indicators.
- ADX is time adjusted, meaning that the most recent data is given exceptional weight.
- ADX helps you identify the strength of a trend, which will be useful for any contract being executed in the near future.
- ADX makes it very easy to compare mutually exclusive futures contracts at once.
Futures traders enjoy using ADX as a metric because it offers the perfect blend of past and present data and future predictability. Successfully purchasing futures contracts will require you to identify which potential contracts are mispriced in the status quo. Using ordinary ADX readings for future contracts makes this possible.
Using ADX readings for major indexes (such as the DJIA, S&P 500, and others) can also help you identify whether the general market is experiencing bearish or bullish conditions.
ADX Indicator Trading Rules
Before going further into the ADX indicator trading rules, let’s define what the ADX indicator is and how you can profit from it.
The ADX indicator simply measures the strength of a trend and whether we’re in a trading or non-trading period. In other words, the ADX is a trend strength indicator. This method of technical analysis is used to identify the emergence of strong downtrends and buy signals.
We need to be very careful about how we read and interpret the ADX indicator. It is not a bullish and bearish indicator. ADX’s moving average only measures the strength of the trend.
So, if the price is going UP, and the ADX indicator is also going UP, then we have the case for a strong bullish case.
The same is true if the price is going DOWN and the ADX indicator is going UP. Then we have the case for a strong bearish case.
The first ADX indicator trading rule says, a reading below 25 signals a period of non-trading or ranging market. The second ADX indicator trading rule says, when the ADX is above 25 is enough to signal the presence of a strong bullish/bearish trend.
Going forward, keep in mind that the ADX indicator doesn’t give you any information about the direction of the market. It just provides you with information about the strength of a trend.
ADX Indicator settings
The ADX indicator uses a smoothing moving average in its calculation. We find out that the best ADX indicator settings to use is 14 periods. With our ADX indicator settings, you’ll have more accurate signals and it will help you get in a trade earlier.
The ADX indicator works best when used in combination with other technical indicators.
The best ADX strategy also incorporates the RSI indicator in order to time the market. The ADX indicator can only help us to gauge the intensity of the trend. We need to RSI indicator for entry signals.
The RSI uses a 20-period setting, which is the same as the ADX indicator settings.
Finally, your chart setup should have at the bottom both the ADX and RSI indicator. It should be the same as in the figure below.
Now, let’s see how you can effectively trade with the best ADX strategy. You will learn how to make profits by applying the ADX indicator trading rules.
The Best ADX Strategy
The ADX indicator trading rules will ensure that you only trade when there is a strong trend on the 5-minute chart or the daily chart. In this regard, the best ADX strategy is a universal strategy that performs the same, regardless of the time frame used.
Moving forward, we’re going to look for selling opportunities.
Step #1: Wait for the ADX indicator to show a reading above 25.
Before we even look to see if the market goes up or down, we must first wait for the ADX indicator to show a reading above 25. Based on the ADX indicator trading rules, a reading above 25 is signaling a strong trend and the likelihood of a trend developing.
We all know that the trend is our friend, but without real strength behind the trend, the newly trend formed can quickly fade away.
In order to gauge the direction of the trend, we also need to look at the actual price action. This brings us to the next step of the best ADX strategy.
Step #2: Use the last 50 candlesticks to determine the trend. For sell signals, look for price to develop a bearish trend.
No matter of your time frame, we need a practical way to determine the direction of the trend.
By using a sample size of 50 candlesticks to determine the trend we ensure that we trade in the moment of now. We like to keep things simple, so if the price is heading lower during the last 50 candlesticks we’re in a bearish trend.
Now, it’s time to focus on the catalyst that will trigger our sell signal for the best ADX strategy.
Step #3: Sell when the RSI indicator breaks and show a reading below 30.
For our entry signal, we’ll be using the RSI indicator that uses the same settings as the ADX indicator settings. Normally the RSI reading below 30 shows an oversold market and a reversal zone. However, smart trading means looking beyond what the textbook is saying.
In a strong trend as it’s defined by the ADX indicator that’s precisely what we want to see. We want more sellers coming into the market.
So, we want to sell when the RSI indicator breaks and shows a reading below 30.
The next important thing we need to establish is where to place your protective stop loss.
Step #4: Protective Stop Loss should be placed at the last ADX high.
In order to determine the stop-loss location for the best ADX strategy, first identify the point where the ADX made the last high prior to our entry. Secondly, find the corresponding high on the price chart from the ADX high and there you have it your SL level.
Last but not least the best ADX strategy also needs a place where we need to take profits, which brings us to the last step of this unique strategy.
Step #5: Take Profit when the ADX indicator breaks back below 25.
The best ADX strategy seeks to only capture those profits resulted from the presence of a strong trend. Once the prospects of a strong trend fade away we look to take profits and wait for another trading opportunity.
To accomplish this we take profits as soon as the ADX indicator breaks back below 25.
An ADX reading back below 25 suggests the prevailing trend is running out of strength.
Note** The above was an example of a SELL trade using the ADX indicator trading rules. Use the same rules but in reverse, for a BUY trade. In the figure below you can see an actual BUY trade example.
Take a look:
Conclusion - ADX Indicator
The best ADX strategy gives us very useful information because a lot of the time, we as traders don’t want to get into something that’s moving nowhere and not trending in a strong fashion. By applying the ADX indicator trading rules one can take advantage of the strength of the trend and cash in quick profits. The bottom line is that the best profits come from catching strong trends and the best ADX strategy can help you accomplish your trading goals.
You can also read about the Trader Profile Quiz.
The best ADX strategy is similar to the Best Momentum Trading Strategy for Quick Profits because both strategies seek to take advantage of the strength of the trend.
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