J. Welles Wilder pioneered an array of popular indicators (ADX, Parabolic SAR, RSI) in his book, New Concepts in Technical Trading Systems
The concept underlying the 2-period ADX is to find the perfect pause in the market. By using such a short look-back period for the ADX indicator, it becomes extremely sensitive. Hence, it rarely falls below 25. When it does, it is a signal that a break-out is imminent.
Learn: The Logic Of The 2-Period ADX
In this trading strategy, we will analyze the trend context to anticipate the break-out direction.
Trading Rules – 2-Period ADX Trend Trading
Bull Trends
- From below the 20-period EMA, price makes a higher swing high above the 20-period EMA.
- 2-period ADX falls below 25 but price is still above EMA. (signal bar)
- Place buy order one tick above the high of the signal bar.
- Cancel order if not triggered by the next bar.
Bear Trends
- From above the 20-period EMA, price makes a lower swing low below the 20-period EMA.
- 2-period ADX falls below 25 but price is still below EMA. (signal bar)
- Place sell order one tick below the low of the signal bar.
- Cancel order if not triggered by the next bar.
2-Period ADX Trend Trading Examples
Winning Trade – Bullish Entry
This is a 5-minute ES chart showing a nice bullish trending session. The purple line is the 20-period EMA, and the lower panel shows the 2-period ADX.
- From below the moving average, price rose and broke above a swing high. That was our signal that a bull trend has begun.
- After rising for several bars, price started to pullback. The pullback consisted of many narrow range bars which stayed above the EMA. The bullishness remained intact.
- The 2-period ADX fell below 25. We bought as price broke above the high of the signal bar.
By placing our stop just below the low of the signal bar, our risk was small. Even with a conservative target price, we could obtain a high reward to risk ratio.
In addition, the 2-period ADX offered a second entry in the later part of the session. That entry was another low-risk entry into the bull trend.
Losing Trade – Bearish Entry
This is another 5-minute chart of ES futures. In this case, the first signal resulted in a loss.
- Price fell below the EMA and broke a swing low, giving us the signal to look for shorts.
- After pushing below the support, the bearish momentum waned. The bearish candlesticks had small bodies. Eventually, a strong bullish bar ended the fall. However, the bullish bar had no follow-through. Instead, price drifted horizontally along the earlier support which has flipped to become a resistance.
- In the sideways trading range, we had two 2-period ADX signals. The first signal failed almost immediately.
However, the trade risk was low. Hence, the potential profits from the second ADX signal more than made up for it.
Review – 2-Period ADX Trend Trading Strategy
The 2-period ADX is an excellent way to find low-risk entries into market trends. Most signal bars are narrow range bars, and its extreme offers a reliable stop-loss level.
The main drawback of the 2-period ADX is that we might get caught in tight trading ranges. However, by combining the 2-period ADX signal with the market bias we identified with price action, we limit our entries to potential new trends. Not only does this method keep us with the trend, it also helps us to avoid false break-outs.
Another characteristic of the 2-period ADX signals is that they occur infrequently. It teaches the virtue of patience in trading. Instead of jumping into a trend as it’s speeding away, exercise patience and join the train during its perfect pause.
Feel free to use your own trend filters instead of what we suggested. The key is to find potential new trends. The signals do not work as well in mature trends.
Is there a typo in step 3 of dealing with Bear trends. Should it not be “Place SELL order one tick below the low of the signal bar.” ?
Yes, it’s a typo. I’ve corrected it. Thanks Peter!
Which time do you recommend for this set up? I noticed that By placing our stop just below the low of the signal bar on a 5minute chart , the stop was too tight and several trades hit the stop loss within a few minute. Also what ADX period to use 14. 25, 50?
I’ve used this setup mainly for day trading. This strategy is by no means a profitable setup when traded mechanically. It merely offers a context to discuss the 2-Period ADX as a trading tool. – ADX(2)
For most of my setup discussions, I use a generic stop placement (at the end of the setup bar) for consistency. The stop placement can clearly be improved on depending on the volatility of your instrument and your targeting methods.
ممتاز
Thanks for the comment. Glad you like it!
Really great article.
Can I ask the settings for ADX for daily? I have DI Period 14 Smooth 14 with ADXR 10 although not sure what the last one does.
And ADX 5 mins DIP 5 Smooth 14?
Thanks.
Connor
Hi Connor, for this setup, use the ADX indicator and not the ADXR (which measures the momentum of ADX). For the ADX, set the lookback period to 2. (The default is usually 14.)
Thanks for sharing,
but I didn’t understand when to exit the trade (take profit).
Hi! There are many ways to take profit and the basic method is to aim for the nearest support or resistance level. You can check out 10 different ways to take profit here.
This is an amazing strategy! I ran through a sample size using this strategy, and I’ve been able to make some of the best, low-risk trades that I’ve ever had. Best of all, I was able to identify the moves before they happened, which is almost like having a crystal ball. By far, this is the most amazing strategy that I’ve come across. What’s even better, is that I’ve configured my charting software (TC2000) to alert me on specific stocks that I’m monitoring when the 2-period ADX dips below 25 on both the 2-minute and 5-minute time frames. Now, all I do is just review the alerts when they come in and focus on the ones that have good chart context for very easy trend trades. Here are a couple of charts for others to see the potential of this awesome strategy:
ROKU – 2/25/19 – https://prnt.sc/mqhx3q
DIS – 2/25/19 – https://prnt.sc/mqhxea
I can’t thank you enough! You are awesome!!!
One quick note… when you’re looking at the chart in real-time, there can be some false-positives. To filter out the false-positives, I like to add some extra buffer.
For example, if I’m waiting for the 2-period ADX to dip below 25, I like to add some extra buffer, meaning that I wait for it to dip below 20.
Great to hear! I really appreciate you sharing your experience with this strategy here. And complete with charts. Fantastic work!
This is really good one. However, I am always getting false positive result for bullish trend, I am running it on crypto with 3m chart and ADX with smoothing period 2 and DI length 2. Is this setup correct or am I doing something wrong here?
Hi Ryan, perhaps you can explore ways to filter the setup. I find that It’s best to set an alert for the pattern but zoom in manually to examine the price action to find the best setups, instead of trading it mechanically.
HI
PLEASE CORRECT ME IF I AM WRONG
IN THE BULL TREND
1. CANDLE IS FORMED ABOVE 20 PERIOD EMA,
AND FOR BEAR TREND
1. CANDLE IS FORMED BELOW 20 PERIOD EMA,
Hi Ganesh, to clarify how we identify a bull trend in the discussion above, first we mark a swing high above the EMA, and once the market breaks above the swing high, we deem it as a higher swing high and adopt a bullish bias.
There are 2 setting in adx on trading view.
1 is ADX smoothing and ADX length both comes in 14 in default. So which 1 I have to change. .?
Hi Satish, please change both settings.