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Trading Strategies

How to Identify and Trade the Strongest Part of a Trend - Part 2

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In the previous article, we looked at how traders can ignore the moving average and instead focus on just the Average Directional Index (ADX) and the Moving Average Convergence and Divergence (MACD) indicators to determine the trend strength.

Before reading this article, it is ideal to refer to the first part of this series to gain insight and context into this trading system.

After defining the trading rules that govern the trend strength, in this part, we look at defining the trading rules and how to trade using the ADX and the MACD indicators.

Trading rules – ADX and MACD

For uptrend, long positions:

  • MACD > signal line
  • ADX > 20 (or 30)
  • Long on closing price with stops at the nearest swing low
  • Book profits regularly and trail the stops

For downtrend, short positions:

  • MACD < signal line
  • ADX > 20 (or 30)
  • Short on closing price with stops at the nearest swing high
  • Book profits regularly and trail the stops

An important distinction to be made here is that while the above rules only signal the trend and don't necessarily mean that traders should enter the trade when the conditions are met.

Once the trend is determined, traders will then have to look for price levels or pullbacks where they can enter into the trend.

In the first example below we have a long position that was taken in the uptrend. Here, after the ADX and MACD signaled the uptrend, the next step was to wait for a pullback in prices, following which a long position is set up.

The trade's take profit levels are set at 1:1 and 1:2 which occurs as the uptrend nears exhaustion.

Long position in a strong uptrend

In the next example, we have a short position which is taken based on the downtrend that was signaled by the ADX and the MACD system.

Here, we can see that the MACD signals a bearish trend with the ADX already above the 20-line. Following the initial decline and the pull back and the eventual breakout we can see that price eventually reaches target 1 and target 2.

Short position in a strong downtrend

The main benefit of using this approach to technical trading is the fact that the system signals you when the trend is the strongest. Therefore, traders can expect to see strong moves in the direction of the trend almost immediately.

Even the stop loss levels that are used are also relatively tight, and the system makes use of a 1:1 and a 1:2 take profit level which is used to limit the risks or the losses.

Trading with ADX and MACD – Pros and cons

The pros and cons of this trading system are quite straight forward. For starters, this trading system is ideal for traders who prefer to enter a trade when the markets are trending strongly. This helps to minimize the losses while also improving the probability of the trades.

On the other hand, traders will need to wait for long periods of time or will have to look for multiple currencies or instruments in order to find the right trading signals.

Traders might succumb to the temptations of entering the trade early on without both the rules being met which could lead to losses. Thus traders who do not have the patience to wait for the right conditions to be met will find that this system will be difficult to work with.

Having said that, seasoned traders will find trading with the ADX and MACD a relatively simple system to trade that also comes with simple trading rules.

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