Bollinger Bands and ADX Strategy

Forex trading with Bollinger bands can be a good way to find breakout and reversal trades. However, it can be difficult to determine if we should trade either the reversal or breakout. This is where the ADX comes into play, which is a popular forex indicator for spotting the trend direction and momentum. When we combine them both to create a Bollinger band and ADX strategy, we can filter out some of the false signals from each indicator and give our forex strategy that extra edge.

What are Bollinger bands?

The Bollinger band indicator was developed by John Bollinger and uses standard deviation of prices and the volatility to create an upper and lower band around the currency pair price. When volatility increases the bands automatically widen and when volatility decreases, they contract. The default period for the bands is usually 20 which is what I like to use.

These bands can act as possible areas of support and resistance. A Bollinger band is calculated 2 standard deviations away from the moving average by default. When price is above the upper band we look to see if it will continue to breakout in an upwards direction or turn around for Bollinger band reversal trade. Likewise, if the price breaches the lower band, we can look for a Bollinger band breakout or reversal trade.

What is the ADX?

The average directional index or ADX for short, is a widely used technical analysis indicator allowing forex traders to analyse if a particular currency pair is trending and gauge the trend strength. The ADX includes 2 lines for the trend direction, the -DI and +DI. When the +DI is above the -DI, this is considered an uptrend. If the -DI is above the +DI, this is considered a downtrend.

When there is an ADX crossover, we can get into a new trend but need to check to make sure the ADX is above 20 so that there is enough momentum for the trend to take off. Trading the ADX trend is a good way to get in the right side of the market, but we still need to time the entry. This is where implementing another technical indicator such as the Bollinger bands comes in handy.

How to trade the Bollinger bands and ADX strategy?

We will combine the key elements of both the Bollinger bands and ADX to make sure that we not only enter in the direction of the trend, but also so that there is enough momentum and we time our entry. Combining the indicators helps to remove market noise and false signals, we wouldn’t want to buy at the top of the market or sell at the bottom. I also like to include price action analysis for further confirmation of any buy or sell signal.

Buy signal

  • Price breached lower Bollinger bands (20, 2)
  • ADX (14) +DI is above -DI
  • ADX (14) is above 20
  • Price bouncing from support or breaching resistance
  • Bullish price action

You can see from the EUR/USD 4-hour chart below that price had broken through the lower Bollinger band but bounced from a support level and headed upwards. The ADX +DI is above the -DI and the ADX is above 20 suggesting an uptrend gathering some momentum. We have bullish candlestick patterns including an inside bar. This all confirmed a strong Bollinger band and ADX buy trade. We could have placed the stop loss just below the support level at around 40 pips. The uptrend went on for at least 800 pips which gave this trend a very favourable risk to reward ratio. You can see that there were a few more ADX and Bollinger band entry signals on this uptrend but it is nice to get in as early as possible to make the most out of each good move.

Bollinger Bands ADX Strategy Buy Signal
Bollinger Bands ADX Strategy Buy Signal

Sell signal

  • Price breached upper Bollinger bands (20, 2)
  • ADX (14) -DI is above +DI
  • ADX (14) is above 20
  • Price bouncing from resistance or breaching support
  • Bearish price action

In the EUR/USD 4-hour chart below you can see that all the condition for an ADX and Bollinger bands sell signal have been met. The price had broken out above the upper band and started to reverse in the opposite direction. The ADX -DI crossed above the +DI and the ADX is above 20 which both mean the market is gathering some downwards momentum. The resistance level has held up well and despite there being some market indecision in the form of doji bars, the sellers eventually won out as evident by the three black crows candlestick pattern. A stop loss placed just above the resistance level would be around 50 pips. The downtrend continued for over 750 pips so there were plenty of pips to be made on this trade. I would have locked in the trade at break even after the first pull back to the middle band and used a trailing stop to maximise the potential of this particular trade.

Bollinger Bands ADX Strategy Sell Signal
Bollinger Bands ADX Strategy Sell Signal

Bollinger bands and ADX strategy Pros & Cons

Pros

  • Can catch some big market moves
  • Can be used on any currency pair and chart timeframe
  • Bollinger bands and ADX indicators are free to use
  • Can combine with other forms of market analysis
  • Trade in the direction of the trend

Cons

  • Requires further confirmation
  • Takes time to learn how to use it correctly
  • Need good money management
  • There will still be false trading signals

Conclusion: is the Bollinger bands and ADX strategy any good?

Yes, as you can clearly see from the example which I have shared here, the ADX and Bollinger band strategy can be very powerful when used correctly. I certainly think it is better then using the indicators on their own but it does require further confirmation in terms of keeping an eye on price action. You will also need to use sensible forex money management as you wouldn’t want one bad trade to cancel out a run of winners. Try to shoot for a favourable risk to reward ratio and consider using a break even and trailing stop to protect winning trades.

If you want to give the Bollinger bands and ADX strategy a try, you could always see how you get on with a free forex demo account that you can get from most forex brokers. This will allow you to buy and sell currency pairs using virtual funds so that you can practice your trading strategies and build some confidence without taking any unnecessary risks.

Free Forex Robot