The ADX and parabolic SAR indicators are both useful for spotting currency pair trends. We can improve the quality of the buy and sell signals that each of these popular forex indicators generate by using them both for confirmation. If the ADX and parabolic SAR both suggest that the market is heading in one direction, that can be better then using just one or the other. Not to mention, the ADX also does a good job of detecting trend momentum which is something the parabolic SAR is lacking. In this guide I will look at a simple ADX and parabolic SAR strategy that you can use to analyse all of your favourite currency pair charts and timeframes to find actionable forex signals.
What is the ADX?
The average directional movement index (ADX) indicator can be used to help measure the overall strength of a trend. The ADX indicator is an average of expanding price range values. The ADX is a component of the Directional Movement System developed by Welles Wilder. It can fluctuate between 0 and 100, whilst it has two lines (+DI and -DI) that can be used to determine the trend direction.
Many traders will use ADX readings above 20 to suggest that the trend is strong enough to use an ADX trend trading strategy. Conversely, when ADX is below 20, many will avoid forex trend trading strategies as the market is range bound. A low ADX value is usually a sign of accumulation or distribution. A crossover of the +DI and -DI lines can be used to signify a change in the trend direction.
What is the parabolic SAR?
The parabolic SAR is a technical indicator that is also developed by Welles Wilder. It is used by forex traders to determine the direction that a currency pair is moving. The indicator is also referred to as a stop and reverse system, which is abbreviated as SAR. It aims to identify potential reversals in the price movement of traded currencies. Some traders also use the PSAR as a place to put their trailing stop loss.
The parabolic SAR (PSAR) indicator uses the recent extreme price (EP) with an acceleration factor (AF) for determining where the indicator dots will appear. It is calculated as follows: Uptrend: PSAR = Prior PSAR + Prior AF (Prior EP – Prior PSAR). Dots above the price signal a downtrend whereas dots below the price signal an uptrend.
How to trade the ADX parabolic SAR strategy?
For this strategy, we will combine all of the different elements of the ADX and parabolic SAR to confirm signals. We will also have a look at price action to see how it reacts around key support and resistance levels. I like to try and time the entry using candlestick patterns. I think by considering all of these elements along with being aware of fundamental analysis, can provide the foundations for a solid forex strategy.
Buy signal
- ADX (14) -DI is above +DI
- ADX (14) is above 20
- Parabolic SAR (0.02, 0.2) is below price
- Price breaching resistance or bouncing from support
- Bullish price action
In the EUR/USD 1-hour chart below, you will see that we have all of the signals for a parabolic SAR and ADX strategy buy trade. There has been a nice support level formed that is holding up well. We can see the ADX +DI line move above the -DI line which shows an uptrend is forming. It is also gathering momentum with the ADX being above 20. The parabolic SAR is below price whilst the entry can be confirmed by a large green engulfing candlestick pattern. The stop loss could have been just below the support level or parabolic SAR which is around 15 pips. This EUR/USD uptrend when on for over 730, with plenty of opportunities to take profits along the way. You should be able to spot on the chart additional entry signals based on the ADX crossover strategy and parabolic SAR changing position.
Sell signal
- ADX (14) +DI is above -DI
- ADX (14) is above 20
- Parabolic SAR (0.02, 0.2) is above price
- Price breaching support or bouncing from resistance
- Bearish price action
You can see in the EUR/USD 1-hour chart below that we have all of the signals for an ADX and parabolic SAR sell trade. Price had just bounced from a resistance level that had been tested a few times and was already on its way down. The ADX -DI is above the -DI and the ADX is also above 20. These are all signals of a downtrend that is gathering momentum which is confirmed with the parabolic SAR being above the currency pair price. We also have the bearish three black crows candlestick pattern to confirm the entry. The stop loss could have been placed just above the resistance level which would have been around 35 pips. That’s not bad at all when you consider the EUR/USD price fell over 420 pips following this entry. You will see there were other entry opportunities on the way down when the parabolic SAR changed back from bullish to bearish.
ADX parabolic SAR strategy Pros & Cons
Pros
- Catch some large forex market trends
- Can enter trends early
- Actionable trading signals
- Any currency pair and chart timeframe
- Parabolic SAR and ADX indicators are free to use
Cons
- Needs additional confirmation
- Will still be false signals
- Takes time to practice
- Requires correct market conditions
Conclusion: does the ADX and parabolic SAR strategy work?
Yes, as you can see from the trade examples that I have shown here, the ADX and parabolic SAR strategy can catch some big market moves. Both of the indicators do a great job at spotting market trends whilst the ADX can measure momentum. However, you will need to time your entry using price action analysis as I wouldn’t blindly take the signals as they are.
You will also need very good forex money management as this can be the difference between a winning and losing strategy. If your stop loss is too wide then one bad trade could cancel out a run of consecutive winners. I would be looking to cut bad trades short and let winning trades run. I might lock in good trades at break even point and trail the remainder of the position using the parabolic SAR as a guide for my trailing stop loss.
If you think that the parabolic SAR and ADX strategy is something that you want to trade with, you could always try it out on a forex demo account to see how things go. You can get a free demo account from most forex brokers, including IC Markets who have quick execution speeds, tight spreads and low fees for trading forex. I would always practice any forex strategy on demo at first in order to get a feel for how it works and see if it produces the desired results before making any financial commitment.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.
