FOREX ARTICLE ON ADX TRADING SYSTEM

I was playing around one day and enjoyed this article. When a trader enters a market, s/he should have a trading system in place and follow it. This includes entry and exit signals, stop loss orders etc. I picked this article up at www.aboutcurrency.com



Steps To Create A Mechanical Forex Trending Trading System



A mechanical forex trending trading system is mainly based on technical indicators and a set of rules to enter and exit trades. Trending systems will only perform well in trending currency markets. Rarely will you get one forex system that is able to exploit both ranging and trending markets.



A mechanical forex trending trading system should attempt to accomplish 2 goals:
1. Be able to identify a new trend as soon as possible
2. Confirm this trend to avoid most false break or whipsaw signals



Step 1: Find technical indicators that help spot a NEW trend.
A very popular overlay indicator among currency traders to spot new trends early are moving averages, a simple currency trending trading system to identify new trends is the moving average cross-over system, this trading system combines 2 moving averages, the long-term and the short-term to create a buy ar sell rule, "when the short term MA crosses the long term MA from below, this will generate a buy signal, conversely, when the short term MA crosses the long term MA from above, this will generate a sell signal. In it's simplest form, moving average crossovers are the fastest ways to identify new trends. It is also the easiest way to spot new trends. The MA Cross System will work very well in trending markets but problems occur during ranging markets. It is during these trading ranges that the MA systems show their weaknesses by generating false breakout signals and eating your profits. The best recommendation is to use MA Cross Systems only during trending market conditions. How do we know the market is in a trend or not? By adding a trend confirming technical indicator.


Step 2: Find technical indicators that help CONFIRM the new trend.
In order to avoid most false breakouts and whipsaws, we have to confirm the new trend by adding a trend-confirming indicator such as MACD or ADX to our MA Cross trending system. Basically, adding ADX or MACD to our system is a method of determining if a market is trending or not.For example, an increase of the ADX for example signifies that the market is trending, either up or down. A decreasing ADX can indicate that the trend is decreasing or moving into sideways action. As a general rule, if the ADX > 25 for MA systems, the new trend is confirmed and the trade should be taken. Hundreds of indicators can help to confirm "new" trends, as you become more familiar with various technical indicators which you can find at our website or download section, you will find ones that you prefer to use over others, and can incorporate those into the MA trending system.How does our MA-ADX system look like?

Step 3: Define your entry rules When to enter the market? Simple, enter the market when your system signals a buy or sell order. In our MA system, entry rules would look like:


1) Buy at market if EMA(5) CrossOver SMA(200) from below and ADX>=25
2) Sell at market if EMA(5) CrossOver SMA(200) from above and ADX>=25

(Notice that this is an hourly chart and this trade is lasting over 10 days so far.)
Step 4: Define your exit and target rules
When to exit the market? Basically, you have to exit the market only when the "new" trend is over, either with a loss or a profit. It is very important to understand and accept that your trending system will generate losses too. Taking profits can be done in many ways and it is just a matter of your trading style.

Some examples:
1) Use a trailing stop-loss to lock in profits meaning that if the currency price moves in your favor by ‘Z’ amount, you move your stop by ‘Z’ amount.
2) Close 1/2 of your position if the trade moves 'Y" pips in your favor, or close the trade completely if the price moves 100 pips in your favor.
3) Choose support and resistance levels as target levels.
4) Simple wait to take profits when your system tells you to do.

Basic exit rules would look like:
Exit the market if:
Stop-loss has been hit
The 5 EMA crosses the 200 SMA back in the opposite direction
ADX falls back below 20 indicating a non-trending market

Step 5: Define your money management rules


As a general rule: Your risk per trade should never exceed 2% of your total equity. For example, if your total equity is $100,000, your risk per trade should never exceed $2000. Most professional currency traders never exceed 1% risk per trade. Money management is very important and will keep you trading.

This trading system has been beneficial so far when paper trading fx.

Good luck trading.
JD