Introduction
MACD (Moving Average Convergence/Divergence Indicator) and ADX (Average Directional Index)are two of the broadest used technical indicators. I’m sure most of you have used them at some point. Combine them together properly and you can create one of the sharpest trading systems out there. Keep reading and learn the results below.
MACD
MACD uses the difference between two exponential moving averages to determine the direction of the trend and its momentum. Using this with the EMA of the MACD itself(the signal line), and we have a dependable indicator. You can read all about its use and construction from How to use MACD in Day Trading?
ADX
The main aim of the ADX indicator is to measure the strength of the direction without any reference to direction. The trend is considered strong if the indicator reaches above the 25 line. On the contrary, if the indicator is below the 25 line, then the trend is weak or the market is not trending. The ADX signals over 30 demonstrate the strong trend to happen – it is definitely the best time to get into the trade.
Traders sometimes prefer to make the use of all three lines of this indicator: ADX, +Di and–Di lines – they interpret the cross of these lines as the additional signal of a possible reversal. And we will be using this exact feature of the ADX in our strategy.
The MACD-ADX Combination
The MACD is going to detect the trend reversals, while the ADX is showing either the trend is strong or fading. Sounds like a nice combo? Then, what are the ideal settings for those two widely-used indicators in order to get the best results?
We tried the MACD and ADX in several combinations and learnt while backtesting them through different markets and parameters. Let’s check how these two indicators work together.
Trade Setup
Timeframe: 15 mins and above.
Indicator settings: MACD(default settings: 12, 26, 9), ADX(default: 14).
Stop Loss/Take Profit: Set the Stop Loss/Target Price over/below the closest swing high/low.
Buy Entry Rules
- MACD rises above zero.
- To confirm the signal D+ line of the ADX indicator higher the D- line.
- ADX line is above 20 and rising upwards.
- On the candlestick where these three conditions are met, you make a Buy.
Sell Entry Rules
- MACD is below the zero line.
- To confirm the signal D- line of the ADX indicator higher than the D+ line.
- ADX line is above 20 and rising upwards.
- On the candlestick where these three conditions are met, you open the Short trade.
How Else You Can Adjust the Strategy
- There are several ways to read ADX indicator, that if the ADX crosses the 20 level – then the trend is getting stronger, if the ADX is over 30 – the trend has gained even more power.
- Aggressive traders can get into the trade when the ADX is below the 20 line, so it gives the possibility to catch the growing trend and not to miss the beginning of it. The basic idea is that the more mature trend is the more possible is the reversal;
- Traders must observe that the cross of the 20 line is not as important as the slopes of the indicator and its direction. Hence, this is not a purely system trade, but some observation and discretion is warranted.
- You must experiment and find your own way to read the indicators and adjust them according to your trading needs. The best way to find out – to backtest any of these settings and pick the one that will work the best for you.
- Take Profit and Stop Loss. We mention in every trade to have a risk reward ratio of 1:2 at least. The same holds here. Money management is at the heart of trading and we will discuss this is future in greater detail.
See you next time!
Note: This article is for educational purposes only. Kindly learn from it and build your knowledge. We do not advice or provide tips. We highly recommend to always trade using stop loss.
