Currency Trading - combining RSI and ADX with Moving Averages
ForexAbode.com
In this article we will see how the ADX (Advance Directional Index) may indicate that we can take a trading position and RSI (Relative Strength Index) pin-points the entry or exit point.
Combining selected technical indicators come in handy is a very dynamically changing markets like Forex. Forex market indeed is very dynamic and the markets trends can change very fast. Uptrend to sideways move to downtrend to uptrend may take place even during one life cycle of a trade.
The following factors need a consideration for our trading decisions:
What is the Trend situation:
- Strong trend
- Trend becoming stronger
- Trend becoming weaker
- Market is running sideways
- A reversal may be on the way
- A break out from the sideways movement is probable
Trend identification is one of the important starting points before taking a position.
How to identify the trend:
ADX: ADX above 25 and rising
Exponential Moving Average: The prices closing above Moving Averages (say 5 to 20 periods for short term trading and 20 to 60 periods for medium term trades). So the price action is above the moving average line and we have a rising moving average line. And this shows a uptrend. ADX being the same if price action was below the MA line and if the moving average line was dropping then it would have indicated a downtrend.
Now once we identify the trend situation we need to identify the entry and exit and also take-profit targets and stop-loss levels. Let’s start with entry point. Simply speaking we can use various crossover methods like MACD (moving Average Convergence Divergence) line with MACD signal line or shorter period SMA (simple moving average)or EMA (exponential moving average) or WMA (weighted moving average) with longer period of the corresponding moving average line. But lets loop in our friend RSI (Relative Strength Index) here. RSI indicates oversold (hence probable buying levels) and overbought (hence probable selling levels). But will overbought and oversold indications work in strong trending market. Probably not again. But if we apply RSI with the knowledge of the trend as mentioned above then we may have a better platform to take decisions. Here comes the art of combining the technical indicators, here we are talking about combining the indicators which we have mentioned above i.e. ADX, Moving Average and RSI.
How do we do that?
Let’s consider above mentioned scenarios i.e.:
- Strong trend
- Trend becoming stronger
- Trend becoming weaker
- Market is running sideways
- A reversal may be on the way
- A break out from the sideways movement is probable
1) Strong trend:
ADX above 30 and rising. Price closing above 20 periods EMA and EMA line rising.
This indicates a strong uptrend. If we wait for RSI to go to oversold position to enter the trade, we will most probably miss the chance to take a buy position. So how to go about in such situation?
1) Entry: Buy when RSI (Relative Strength Index) goes to the range of 68/70.
2) Exit: Exit or take profit when ADX stops rising and/or RSI dips below 50 and/or price action closes below the 20 days EMA. The take-profit targets mentioned are indicative as the exit also depends on various factors and market situation/volatility and the decisions need to be dynamic. In strong trends I suggest to use trailing stop-losses and rising take-profit levels.
3) Stop-Loss: Use trailing stop-losses. Stop-losses would depend upon the volatility. if the price movement is quite volatile then the stop-loss would be wide. It could be a few pips below the previous candle's low. as mentioned if the market is very volatile then the stop-loss margin has to be more otherwise even if upward movement continues, the narrow stop-loss margin may close the position with a loss. .
2) Trend becoming stronger:
(lets take the example of uptrend)
ADX is above 25 and rising. Price closing above 20 periods EMA and EMA line rising and hence an uptrend.
1) Entry: Buy when RSI (Relative Strength Index) goes below 50 mark.
2) Exit: Exit or take profit when ADX stops rising and/or RSI drops below 40/42 and/or price action closes below the 14 days EMA. The take-profit targets mentioned are indicative as the exit also depends on various factors and market situation/volatility and the decisions need to be dynamic.
3) Stop-Loss orders: Use trailing stop-losses. Stop-losses would depend upon the volatility. if the price action is very volatile then the stop-loss would be wide. It could be a few pips below the previous candle's low. As mentioned if the market is very volatile then the stop-loss margin should not be very close to the entry level otherwise even if upward movement continues, the narrow stop-loss margin can close the position with a loss, if price takes some corrective action. Stop loss could be a few pips below the previous candle's low.
3) Weakening trend:
ADX above 25 but not rising. The 20-period EMA is rising but slowly.
1) Entry: Buy when RSI (Relative Strength Index) goes below 50.
2) Exit: Exit or take profit price closes below 14-period EMA. The take-profit targets mentioned are indicative as the exit also depends on various factors and market situation/volatility and the decisions need to be dynamic.
3) Stop-Loss orders: Use trailing stop-losses. Stop-losses would depend upon the volatility. if the price movement is quite volatile then the stop-loss would be wide. It could be a few pips below the previous candle's low.
In the above examples we have considered an uptrend. During the downtrend we can take short-positions when the EMA is dropping and price action remains below EMA (opposite to uptrend). ADX readings should remain same as above example because ADX only indicates the strength of the trend and not the direction. And we can take short-position when RSI (Relative Strength Index) moves over 50.
You may check the details about these indicators on ForexAbode.com at following links:
ADX
RSI
MACD
Article submitted Sunday, June 12, 2011 & read 34 times.
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