Most professional traders use swing trading to accomplish quick gains within the short term.
Swing trading is pretty similar to intraday trading, where traders hold positions over the short term. A swing trader could be looking for an hour, a day, or a few days. It all depends on the opportunities provided by market movement.
To capitalise on the market movements in the short term, traders use indicators that help them to gain a viable profit. The Average Directional Index (ADX) and Bollinger band are two technical indicators that help traders benefit from price swings.
ADX (Average Directional Index)
The ADX indicates the strength of the existing price movements. The indicator is the exponential moving average of the Directional Index (DX), which forms two indicators: the positive directional index (+DI) and the negative directional index (-DI).
The positive directional index (+DI) measures the strength of upward price moves while the negative directional index (-DI) calculates the power of downward price moves.
Both the +DI and –DI lie within the ADX indicator window that has a range of zero to 100. The average period used in the ADX indicator is 14.
If the ADX line is above the 50 level, with an upward price movement, it means that the price will continue in the prevailing uptrend and vice versa.
However, if the ADX line goes below the 40 level, in a downward price movement, that could indicate a change in trend toward upward movement and vice-versa.
A lot of traders use the Bollinger bands for swing trading. It usually indicates the turnaround in price movement.
The indicator is made up of three curves drawn with the help of standard deviations and moving average. The lower and upper bands are standard deviations of the middle band, which is a moving average of a definite point.
The middle band of the Bollinger band has a value of the 20-day moving average. The upper and lower bands are two standard deviations away from the middle band.
When the price breaks through the upper Bollinger band, it indicates that an asset has been overbought. It also suggests that there is a possible price liquidation as well as profit booking.
Price breaking through the lower Bollinger band suggests that the market players have oversold the asset and the price needs to cover the losses.
In a scenario where price moves up from the lower band, the middle band (EMA of 20) would be the first resistance that price tests. If the price can break through the resistance at the middle band, it will continue moving toward the upper band.
When the price moves from the upper band, the middle band would be the first support price test. If the middle band fails to sustain the support and price breaks through, the lower band will be the next level a trader watches.
How to combine ADX and Bollinger bands on the trading chart
Professional traders usually look out for the price to test either the upper or lower bands of the Bollinger for a reversal to happen. Then, they use ADX to confirm the strength of the reversal based on the position of the ADX line.
Strategy to follow when price touches the upper Bollinger band
If a candle touches the upper Bollinger band from an existing uptrend, traders will watch to see if the ADX line crosses above the 50 level. If it does, they enter a sell position because the price reversal will be strong.
Moreover, it’s wise to wait for the candle that will form a lower high and lower low to confirm the strong reversal.
At this time, traders expect to see a selling pressure while they closely watch the middle and lower bands to know when the price starts to react.
If the ADX line goes below the 50 level as the price candle tests the upper band, a trader can hold the asset because it might only be a fake breakout.
To confirm the hold, wait for the next candle that forms a higher high and higher low.
Strategy to follow when price touches the lower Bollinger band
If a price candle tests the lower Bollinger band from a prevailing downtrend, a trader must check if the ADX line is below the 20 level. At that point, a trader can open a buy position.
It’s also crucial to wait for the next candle to form a higher high and a higher low to confirm the trade.
If the price candle tests the lower band from a prevailing downtrend while the ADX line is between the 20 and 50 level, it’s wise to hold. In other words, the market may be experiencing a range and a possible continuance of the existing downtrend. To exit, the ADX must go below the 20 level.
Here’s an image showing price reaction on the ADX and Bollinger band in a one-hour time frame.
The above EUR/USD chart is on a one-hour time frame. Price is initially moving upward in a strong trend. Then, price the breaks through the upper Bollinger band; at the same time, the ADX line is below the 50 level.
As this happens, the price experiences a sharp reversal and continually drops. In this scenario, a trader can keep holding the sell position for a day until the price touches the lower band and the ADX line is below the 50 level. That would be a great place to exit the trade as a swing trader.
Here’s an image showing price reaction on the ADX and Bollinger band in a four-hour time frame.
The above USD/CAD chart is on a four-hour time frame. Here, price touches the lower band from a range formed from a prevailing downtrend. Meanwhile, the ADX line is below the 20 level. At this point, prices reverse upward. Therefore, entering a buy position at this time is wise.
Ten candles away from the entry point, we see a range/sideways market, where the price doesn't have any significant movement. At this point, the ADX line is dancing around the 50 level.
The bottom line
Combining the ADX and Bollinger Bands from a swing trader’s point of view is quite profitable. However, the strategy is often moot concerning the point of exit when there’s an adverse price movement.
Therefore, it’s wise to use other indicators that will give you signals, such as the Parabolic SAR to exit the market or provide a reliable stop-loss point during a strong price movement.