RSI and ADX Strategy

The RSI and ADX indicators can do a good job at identifying trends, momentum and extreme market conditions. Many forex traders would choose between one or the other, but if you combine them together then you can filter signals for extra confirmation and better setups. If you add into this some price action analysis and keep an eye on important support and resistance levels, you can build a simple yet effective forex strategy which can be used on any currency pair and chart timeframe.

What is the RSI?

The relative strength index (RSI) is a technical indicator that can spot extremely overbought or oversold market conditions where price may change direction. This is a typical RSI crossover strategy and perhaps the most popular way to use the RSI indicator. RSI divergence can also be used to identify which direction the market is heading to ensure we stay on the right side of a trend.

What is the ADX?

The average directional index (ADX) is a trend trading indicator that is used to quantify the direction and strength of a trend. It is plotted as a single line with a value between 0 and 100. It also has a +DI line and -DI line which determines if the current market is in an up or down trend. An ADX crossover above the 20 level suggest the market is trending with some momentum.

How to trade the RSI and ADX strategy?

Whilst both of the indicators are good in their own right, they can be significantly improved when combined together. I find that using one indicator on its own can lead to many false signals. We will take all of the important elements of the ADX and RSI indicators and use them together to confirm our entry into the forex market.

If the RSI is above the 70 level, we consider the currency pair to be overbought so will look for an RSI reversal trade to the downside. You can confirm this by seeing if there is any RSI divergence heading downwards as well. The ADX trend should also show that the -DI is above the +DI line and the ADX level is above 20. Entry will be confirmed when price is bouncing from a resistance level or breaking out through support.

On the other hand, if the RSI is below 30 and showing upwards divergence, the ADX -DI is above the +DI and the ADX is greater than 20, then we would be expecting the market to go up. Again, we would confirm entry by watching how price reacts around key price levels whilst we can time our entry using candlestick patterns.

Buy signal

  • RSI (14) is below 30
  • RSI (14) showing upwards divergence
  • ADX (14) +DI is above -DI
  • ADX (14) is above 20 level
  • Price bouncing from support or breaching resistance
  • Bullish price action

You can see in the USD/JPY 1-hour chart below that all of the conditions for an ADX and RSI buy trade have been met. The RSI is around the oversold 30 level and the ADX has crossed upwards with momentum above the 20 level. Price has bounced from a support level and the RSI is showing divergence to the upside. We have a double bottom candlestick formation confirming the entry along with some big green bars. A stop loss placed just below the support level would have been 30 pips which is acceptable especially when you consider that this uptrend lasted for over 800 pips. There were additional entry points on the way up when the ADX crossover happened again a few times. I would have been looking to lock this trade in at break even point and used a trailing stop to maximise the move as much as possible.

RSI ADX Strategy Buy Signal
RSI ADX Strategy Buy Signal

Sell signal

  • RSI (14) is above 70
  • RSI (14) showing downwards divergence
  • ADX (14) -DI is above +DI
  • ADX (14) is above 20 level
  • Price bouncing from resistance or breaching support
  • Bearish price action

In the USD/JPY 1-hour chart below, you can see that all of our conditions have been met for a sell trade based on the RSI and ADX strategy. We have the RSI above 70 but showing downwards divergence. The ADX -DI is above the +DI and the 20-level showing selling momentum. Price has formed and tested a resistance level that has held up well. There was some market indecision as evident with doji bars but the sellers came out winners in the end as shown by the head and shoulders candlestick formation. We could have placed the stop loss just above the resistance level which would have been around 20 pips. That’s not bad when you consider price fell around 850 pips, giving ample opportunity to take profits on the way down. There are also multiple re-entry opportunities in this down trend where the ADX crossover happens again. See if you can spot them in the chart.

RSI ADX Strategy Sell Signal
RSI ADX Strategy Sell Signal

RSI and ADX strategy Pros & Cons

Pros

  • Capture trends from the start
  • Buy low and sell high
  • Filter out some false signals
  • Can be used with other indicators
  • Any currency pair and timeframe
  • RSI and ADX are free to use

Cons

  • Requires some practice
  • Need to time entry and exit
  • Will still be false signals

RSI vs ADX

The RSI and ADX complement each other quite well because they both serve a different purpose. The ADX is great for spotting market trends and momentum, whereas the RSI is good for identifying possible overbought or oversold market conditions. This means we can trade pullbacks into the trend when there is still plenty of momentum. If they were used standalone, they could produce lots of false signals. Even together this is still possible, which is why I would always confirm signals with price action analysis and have good money management in place.

Conclusion: is the ADX and RSI strategy any good?

Yes, as you can see from the trade examples that I have shown here, trading forex with the RSI and ADX strategy can be very powerful. We are able to identify and enter new trend at the beginning. However, there will be false signals which is why it is important to conduct in-depth price action analysis and also make sure you have excellent forex money management. This can be the difference between a losing and winning forex strategy.

If you think the RSI and ADX strategy is something that you would like to try, 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 manual and automated forex trading strategies. 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.