› Forex trading strategy based on Parabolic SAR and ADX technical indicators.

Forex trading strategy based on Parabolic SAR and ADX technical indicators.

Most of the trading strategies are focused on identifying a moment when trends change the direction. Finding reversal points is crucial for both approaches taking in count retracement depth and complete divergence of the price action compared to the recent movement. Sometimes even sideways consolidation ranges bring profits from both sides of the market and it’s getting more important to calculate an accurate reversal point possible. However, most of the trend indicators have a lagging disadvantage as they take in the count a previous period, confirming the reversal pattern when it’s rather late to enter the market. There are periods when trend indicators give false signals, misleading a technical retracement with a general trade change. That’s why additional technical tools are needed for any trading algorithm, helping traders to get the second level of the analysis and additional confirmation of the trading signal.

Forex trading strategy based on Parabolic SAR and ADX are working exactly in this way with main and secondary tools to monitor. Parabolic SAR works here as the trend indicator, showing moments when the likelihood of price direction change is larger than normal. It’s also known as ‘stop and reverse’ system with one of the most crucial parameters for the technical analysis - momentum. Once bulls’ or bears’ power is starting to get exhausted, that moment would be ideal for traders to monitor the market conditions more closely. Parabolic SAR has a simple way of graphical indication with dots below (bullish) or above (bearish) the price. Once the appearance of those dots changes - that’s a trading signal to enter the market with the opposite direction to the current trend.

Welles Wilder was the person who developed Parabolic SAR, a technical guru, involving the wide usage of one of the most popular oscillators - Relative Strength Index. The key mathematical idea of Parabolic SAR is rather similar to RSI with the indicator monitoring the price momentum, pointing to the periods when the price accelerates. At the same time, important graphical data comes from simple dots below or above the price when the market is intended to change the direction BEFORE it happens. In contrast to traditional slow trend indicators, like MACD for example, Parabolic SAR has rather a fast reaction time.

 Parabolic SAR
Source: Investopedia


The main disadvantage of Parabolic SAR is that it does not work in sideways range when the price often changes the direction. It gives a lot of false signals due to the nature of any choppy market, so the best profitability is reached on fast entries with tight stop-loss and take-profit orders. However, Parabolic SAR also works well as the method of setting monitoring the best exit time. That issue could be one of the most crucial for maximizing the profitability as traders often close profitable positions too early.
On the other hand, Parabolic works well in the combination with ADX technical indicator. Several types of this tool exist while the most efficient is the one with -DI and +DI additional lines. Make sure that you’ll see three lines in the ADX indicator window because this trading strategy is based on exactly the same indicator. Other variations of ADX might not work well in a combination with Parabolic SAR.

The nature of the ADX is based on fast-moving deviations of the price momentum which is more closely to the oscillator side than to the trend indicators. The full name of this technical tool is the Average Directional Index with two secondary lines called Negative Directional Indicator (-DI) and Positive Directional Indicator (+DI). The ADX measures momentum strength, pointing to the moments when the chances for trend reversal are high. It does not have oversold or overbought levels, in contrast to traditional oscillators, however, it has lines showing strength or weakness of the current price action. Meaning that traders can understand how far the latest movement can go, looking at the current situation where all three ADX lines are placed.

This Forex trading algorithm uses modified settings for both Parabolic SAR (0.02, 0.2) and ADX (period 28). Any timeframe could be used for trading with this strategy, as well as any currency pair could be chosen. However, traders should remember about money management rules and risk limitations when choosing an asset. The depth of stop-loss and take-profit orders has to be correlated with the timeframe. The shorter timeframe is, the tighter stop-loss order should be.

The key condition for long positions, according to this trading strategy, is the Parabolic SAR is performing a bullish pattern (dots are below the price). If that’s in play, ADX indicator has to be monitored in order to find a moment when ADX line value is rising above 13 level with +DI line above -DI line. When the +DI line is below the -DI line, all Parabolic buy signals must be ignored as both tools are showing divergence but not signal confirmation.

The key condition for short positions, according to this trading strategy, is the Parabolic SAR is performing a bearish pattern (dots are above the price). If that’s in play, ADX indicator has to be monitored in order to find a moment when ADX line value is above 13 level with +DI line below -DI line. When the +DI line is above the -DI line, all Parabolic buy signals must be ignored as both tools are showing divergence but not signal confirmation.

Once the position is opened, it’s becoming crucial to watch ADX for the opposite signal when -DI and +DI lines cross each other again. If that happened, the position has to be closed manually by the market price whether it’s in current profit or not. The same condition for exiting the market is relevant to the change in Parabolic SAR pattern. Once it’s showing the opposite signal with dots getting above the price (for long positions) or below the price (for short positions), then the deal has to be closed immediately. Trailing stop orders can be used as well, but the depth of possible retracement depends on the asset and timeframe chosen.

The example of using Parabolic SAR and ADX for entering and exit signals can be found on the chart below:

Forex trading strategy based on Parabolic SAR and ADX technical indicators.


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