The ADX is a top technical indicator which can be used to identify trend reversals and market momentum. When you combine the ADX with support and resistance, you can identify opportunities to enter a currency pair trade at the start of a new trend using an ADX reversal strategy. This is better than simply taking all of the ADX signals without consideration to where price is at relatively speaking. You could end up selling at the low or buying at the high is you are not careful, which is why I like to use the ADX indicator alongside price action analysis to try and catch the start of a big market trend.
What is the ADX?
The Average Directional Index or ADX for short, is a widely used technical analysis indicator allowing traders to analyse if the market is trending and gauge the trend strength. It is an excellent trading tool for monitoring market movements, with the ADX indicator ranging from 0 to 100.
According to its creator Welles Wilder, the values over 25 denote a strong trend while the values under 20 indicate a weak trend, implying that the market fluctuates within the trading range.
The ADX also has 2 lines known as the Positive Directional Indicator (+DI) and the Negative Directional Indicator (-DI). When the +DI is above the -DI it suggests there is an uptrend. If the -DI is above the +DI, the market is considered to be in a down trend.
- ADX line helps traders identify the strength of the trend not the direction of it
- +DI line determines the strength of the upward price movement
- -DI line shows the strength of the downward price movement
ADX reversal forex trading strategy
For the ADX reversal strategy we are going to first look for an established trend in either direction. Once we have spotted a big downtrend or uptrend, we will look for an ADX reversal to try and enter the market when it turns around. We can use support and resistance as confirmation that a trend may have ended. We will also look for candlestick patterns to confirm the reversal.
Buy signal
- ADX is above 20
- ADX +DI is above the ADX -DI
- There is a clear downtrend
- Price has hit support
- Bullish price action
In the EUR/USD 1-hour chart below, you will see that the ADX is above 20 and the green (+DI) line is above the red (-DI) line. Price has bounced of a support level multiple times following a big downtrend. There are lots of bullish chart formations, including inverted hammers and morning star dojis. This all suggests an ADX reversal signal, which went on to see an uptrend that reached over 700 pips. We could have placed a stop loss just below the support level which would have been around 30 pips, giving this trade a superb risk to reward ratio.
Sell signal
- ADX is above 20
- ADX -DI is above the ADX +DI
- There is a clear uptrend
- Price has hit resistance
- Bearish price action
If you take a look at the EUR/USD 1-hour chart below, you will see that all of the conditions for an ADX reversal signal have been met. There is an uptrend that hit a resistance level which it started to move away from. The ADX -DI is above the +DI and the ADX is also above 20 showing momentum in a downwards direction. There are lots of bearish candlestick patterns, including shooting stars and hanging man formations. If we placed the stop loss just above the recent high (resistance), this would be around 30 pips. This downtrend continued for almost 800 pips which would have been an excellent trade. It shows how good the ADX reversal can be at entering the start of big trends if you time it correctly and use additional confirmation.
ADX reversal strategy Pros & Cons
Pros
- Spot trends early
- Gauge market momentum
- Can be used on any currency pair
- Can be used on any chart timeframe
- Can catch some big moves
- Can use with any other indicator
Cons
- Need to filter signals
- Requires sensible money management
- Take time to learn how to trade
Conclusion: is the ADX reversal strategy worth trying?
Yes, I think the ADX reversal strategy can be a great way to get into new market trends at the very beginning. However, there will be lots of false signals which is why it is so important to confirm each buy and sell signal with additional market analysis using other indicators and price action.
You will also need excellent forex money management. It does not matter how good the forex strategy you are using it, if you have poor money management then this can have a negative impact on the results. E.g. a trader who uses a wide stop loss that can wipe out 10 good trades with 1 bad trade, is probably not going to perform as well as a trader that has a positive risk to reward ratio.
If you want to give the ADX reversal strategy a try, you could always do so on a forex demo account. This will enable you to get a feel for how it works and see if it fits within your trading style. You can get a free forex demo account that comes preloaded with virtual funds from most forex brokers.
If you start seeing consistent results, you may then consider switching to a live account, even if you only use micro/mini lots to begin with. This can still give you an idea of what it is like trading in a live environment where trader emotions can come into play and have an impact on how you trade.
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.
