Forex -how To Use Combination Of Rsi And Adx?

By Author: Himanshu jain
Total Articles: 1
Comment this article

Forex market in general is quite dynamic and the market dynamics keeps changing. Today there can be a trend (up or down), the trend can become stronger after some time or can gets weaker or it can go into sideways or a reversal may take place. And what's more all this can happen during the life cycle of a single trade.

In such dynamically changing situations is it a good idea to depend on one technical indicator to make our decisions for entry, exits, taking profits or putting stop-losses? Probably not. How do we take our trading decisions depends on the following factors:

Trend situations:

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

So I would say that the trend identification is one of the important starting points.

Now for trend identifications we can use the following:

For uptrend:

ADX (Average Directional Index): ADX above 25 and rising
Moving Average: The prices closing above Moving Average (say 5 ...
... to 20 periods for short term trading and 20 to 60 periods for medium term trades). So price action above the moving average and the moving average line is rising.

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 and divergence) with MACD signal line or shorter period SMA or EMA or WMA with longer period of the corresponding moving average line. But let’s 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 the ones we have mentioned above i.e. ADX, Moving Averages 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

Strong trend:


Let’s consider uptrend

ADX is above 30 and rising. Price closing above 20 periods EMA and EMA line is rising.

Let’s say that its an 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?

Entry: Buy when RSI (Relative Strength Index) goes to the range of 68/70.
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.
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.

Uptrend becoming stronger

ADX above 25 and rising. Price closing above 20 periods EMA and EMA line rising.

Entry: Buy when RSI (Relative Strength Index) goes below 50.
Exit: Exit or take profit when ADX stops rising and/or RSI dips 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.
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.

Trend becoming weaker

ADX above 25 but not rising. The 20-period EMA is rising but slowly.

Entry: Buy when RSI (Relative Strength Index) goes below 50.
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.
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.

During the downtrend we can take short-position when the EMA is dropping, prices closing below the EMAs as against closing above (opposite to uptrend). ADX reading will remain same as above example as ADX (Average Directional Index) only tells the strength of the trend and not the direction. And we can take short-position when RSI goes over 50.

To know more about ADX (Average Directional Index) and RSI (Relative Strength Index) check once http://www.forexabode.com because you can get all details briefly.