The ADX and stochastic indicators are very good for spotting changes in trend direction and momentum when used alone. However, if we combine them together then we can get even more powerful trading signals and filter out false signals that can occur when only using one of the other. In this guide I will look at a simple ADX and Stochastic 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 index (ADX) is one of the most popular technical indicators used in the forex market to understand if a currency pair is ranging or trending, and the momentum that any current trend has. An ADX reading above 20 is a sign that the trend is gathering momentum. Anything below that can be a sign of a ranging market.
The ADX contains a +DI and -DI line which can be used to determine the trend direction. The +DI above the -DI suggests an uptrend, whereas the -DI above the +DI suggest a downtrend. The ADX crossover strategy can be used to time entry into a new trend but we can improve our probability by using other indicators to confirm trades, including the stochastic oscillator.
What is the stochastic oscillator?
The stochastic oscillator is another popular technical analysis tool that indicates momentum by comparing a particular currency pairs closing price to a range of prices over a specific period, utilising a 0–100 bounded range of values. If the stochastic is above 80, the market is considered overbought, whereas a stochastic reading below 20 suggest an oversold market.
The stochastic main line crossing the signal line upwards suggests a buy signal, whereas the stochastic main line crossing the signal line downwards suggests a sell signal. This is a basic stochastic crossover strategy which can be even more powerful when it happens in either of the extreme zones.
How to trade the ADX and stochastic strategy?
We will combine elements of the ADX and stochastic indicators to create a more complete forex trading strategy when compared to using them individually. I would also keep an eye on price action, especially to see how price reacts around key support and resistance levels. The more confirmation we can get on our trades, the better. Without over doing it and confusing ourselves.
What we are looking for is a currency pair where the ADX is showing a strong uptrend or downtrend with momentum. We then look to time our entry into this trend using the stochastic crossover in an extreme zone. The goal is to try and get into big trends at the earliest opportunity but timing our entry during a pullback. This can help to avoid buying high and selling low.
- ADX (14) +DI is above -DI
- ADX (14) is above 20 level
- Stochastic (5, 3, 3) is in the oversold zone (<20)
- Stochastic (5, 3, 3) main line has crossed signal line upwards
- Price is moving away from support or breaching resistance
- Bullish price action
In the GBP/USD 4-hour chart below, you can see that we have all of the conditions met for a stochastic and ADX buy trade. The ADX +DI is above the -DI and the ADX is above 20, showing we are in an uptrend that is gathering some momentum. The stochastic main line has crossed the signal in upwards in the extreme oversold zone. Price is moving away from a support line that has held up well and there is bullish price action including a double bottom candlestick pattern. We could have placed the stop loss just below the recent swing low which is around 40 pips. Not bad when you consider this uptrend continued on for at least 900 pips. See if you can spot the additional stochastic crossover entries on the chart as the trend continued upwards.
- ADX (14) -DI is above +DI
- ADX (14) is above 20 level
- Stochastic (5, 3, 3) is in the overbought zone (>80)
- Stochastic (5, 3, 3) main line has crossed signal line downwards
- Price is moving away from resistance or breaching support
- Bearish price action
You can see that all of the conditions for an ADX and stochastic strategy sell trade were met in the GBP/USD 4-hour chart below. The price has bounced away from a resistance level and the ADX is showing strong downwards momentum by being above 20 and having the -DI above the +DI. The stochastic crossover to the downside has also occurred in the overbought zone. We then have bearish price action to confirm the entry including a large red engulfing bar which shows the sellers are winning this battle. This trade could have bagged over 1,750 pips with a relatively tight stop loss. You will also see numerous entries based on the stochastic crossover on the way down.
ADX stochastic strategy Pros & Cons
- Catch some big market trends
- Confirmation from each indicator
- Can be used with other technical indicators
- Actionable buy and sell signals
- ADX and stochastic indicators are free to use
- Requires good timing for entry and exit
- Need to study price action for confirmation
- Takes time to learn how to spot trades
- Must have good money management and discipline
Conclusion: is the ADX and stochastic strategy worth trading forex with?
Yes, I think that forex trading with the ADX and stochastic strategy can help traders to catch some big market moves when they know how to time their entry. It does require the user to understand price action and look for how price reacts around important price levels. I wouldn’t blindly take any stochastic or ADX signal without further confirmation.
Not to mention, you will need a solid forex money management strategy. I wouldn’t want to use a wide stop loss that could wipe out all of my gains. I might to lock winning trades in at break even point as nothing is more frustrating than seeing a winning trade turn into a losing trade. I may then trail the position using a trailing stop loss to get the most out of any currency pair trend.
If you think the ADX and stochastic strategy is something that you find interesting, you could always test it out on a demo account to see how things go. You can get a free forex demo account from most forex brokers, including IC Markets who have tight spreads and low fees for trading forex manually and using forex robots. I would always practice any forex strategy on demo at first in order to understand how it works and see if it produces good results before making any 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.