This is the third article in our ADX series. If you haven’t already, we suggest that you check out the first article about the ADX Indicator. In the previous two articles, we have covered the history, the calculations involved, and how to use and read the ADX indicator. The ADX indicator will typically have three lines, one each for measuring descending and ascending trends (referred to as “DM” or Directional Movement lines), and then the “signal” line that represents the “absolute” force of either the ascending or the descending trend.
Forex traders use technical analysis to determine optimal entry and exit points in the market. They focus on the ADX key points of reference, which are highpoints and line crossovers. As with any technical indicator, an ADX chart will never be 100% correct in the signals that it presents, but the signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding ADX signals is developed over time. In the example below, let’s develop a simple trading system based on ADX signals and alerts.
The following trading system is for educational purposes only. Technical analysis takes previous pricing behavior and attempts to forecast future prices, but, as we have all heard before, past results are no guarantee of future performance. With that disclaimer in mind, the “yellow” circles on the above chart illustrate optimal entry and exit points that can be discerned from using ADX analysis.
A simple trading system would then be:
- Determine your entry point when the “green” line crosses the “gold” line in an upward movement, accompanied by the ADX “signal” line moving in a similar direction as the “green” line;
- Execute a “Buy” order for no more than 2% to 3% of your account;
- Place a stop-loss order at 20 “pips” below your entry point;
- Determine your exit point when an upwardly moving “signal” line peaks at a value above the 40 mark, accompanied by a rising “gold” line.
Steps “2” and “3” represent prudent risk and money management principles that should be employed. This simple trading system would have yielded two separate 100 “pip” gains, but do remember that the past is no guarantee for the future. However, consistency is your objective, and hopefully, over time, ADX Technical Analysis will provide you with an “edge”.
That concludes our series on the ADX Indicator. For further reading visit our Forex indicators section.
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We also recommend you to read about the Heiken Ashi Strategy.