Welcome to the third indicator study. This research represents an investigative look into how and why some indicators work and some don’t work as well.
New Versus Old
Volume indicators, for the most part don’t have as much breadth in variety as other indicators such as entry, exit, confirmation and baseline. We’re going to start with an older volume indicator called the Average Directional Movement Index, or ADX. It was developed way back in 1978. It’s definitely not great by any standard and is included in the dirty dozen, but for illustration purposes, we’re going to start with this one.
Interestingly enough, measuring volume in the Forex market isn’t necessarily the same as measuring volume in other markets, such as the stock market, which can be tracked in a much more coalesced fashion.
The issue with currency volume is that the entire FOREX system is decentralized, so the volume you see on your trading platform is not the entire market, but whatever portion is accessible by your broker through interbank. It’s okay though. The numbers we see on our trading platform are sufficient to determine if volume exist in that specific pair and in that current market condition.
Our Third Indicator Choice is…
We’ve chosen to begin our adventure into volume using the pre-packaged ADX indicator found in the MT4 platform to examine as our third indicator choice. But don’t worry, we’ll be exploring newer volume indicators in future blogs to demonstrate different representations of volume.
So, why do we even need to be concerned with volume. Surprisingly, many traders don’t really bother paying attention to it. Usually, because they don’t understand it. Without volume, markets don’t have the “fuel” they need, which provides the prolonged trends we depend on to make low stress, high probability trades.
A “volume indicator” falls into the category of indicators that serve as a final checkpoint after the baseline and confirmation indicator conditions have been met (see the blog on Hull Moving Average for a baseline indicator HERE or the non-lag MACD indicator blog for a confirmation indicator HERE) when setting up your algorithm. These concepts are explained in great detail in the Stonehill Forex Advanced Course (HERE).
Trading volume can help an investor identify momentum of a currency pair and confirm a trend. If trading volume increases, prices generally continue to move in the same direction and can provide a heads-up if volume diminishes. Once volume begins to diminish and the fuel for the trend starts to dry up, a reversal or ranging market may be on the horizon.
Below is a screenshot of what the indicator looks like on the daily time frame. Note that we’ve changed the color of the candles to white to remove any emotional bias so that only the indicator is prominent.
Pretty messy. Let’s clean it up by removing two of the lines; the “yellow-green” and “wheat”, which represent the bullish and bearish indicators. We only want to keep the “LightSeaGreen” line, which represents volume. We’ll make those adjustments in the settings screen, on the colors tab.
Now, it looks much cleaner.
We’re also going to add a midpoint line by adding the top and bottom numbers on the right, dividing by two and then using that as our “zero line”.
So, if we add 56 (it’s okay to round) and 2, we get 58. Divide that by two and we’ll use 29. Now, we’ll add that level as our “zero line”. We’ll make those adjustments in the settings screen on the levels tab.
Now, we have our “zero line”.
How it’s Used
Like the non-lag MACD, crossing above or below the “zero line” provides our signal. It’s that simple. Used in conjunction with baseline and entry indicators, the confluence (when multiple things in agreement raise the level of confidence) of indicators increases your odds of a successful trade. See the example below.
Note: We’re only demonstrating the volume indicator by itself here. Never trade with just a volume indicator.
You can see the winners and losers here. As a stand alone, even the losers are relatively small if you have solid money management.
There is only one setting (other than colors and levels) which can be changed. That would be the period. The default value is 14.
It Bears Repeating
As we’ve said in past blogs (and will continue to do so), some text below is repeated as reminders and suggestions of the testing parameters. Feel free to skip down to the results.
As mentioned in previous studies, we strongly advocate backwards and forward testing indicators or systems prior to trading actual funds, the task of manually sorting signals through more than 70-130 available currency pairs is daunting at best. That being said, we suggest conducting your tests on the following five pairs.
Recall that if it doesn’t work on these five pairs, chances are it won’t work on other pairs. Granted, this is not an absolute, but we’ve found that this rule is pretty reliable in most cases.
Timeframes and Results
In our initial test, we’ll run the ADX on the EURUSD using the default settings 14 across the daily and 4-hour timeframes on the MT4 strategy tester. We’re using the fast method of testing the indicator to get a general idea; however, you may also run the tick-by-tick data set for a more precise result (which takes considerably more time).
As No Nonsense Traders – and therefore swing traders, we won’t be examining shorter time frames in these studies. Then we’ll run multiple iterations using combinations of the three settings to see which ones work best and examine the results:
1. Total trades
2. Win/Loss ratio
3. ROI (return on investment)
There are many other metrics included in the strategy tester report, which can be compared, but these three metrics provide the necessary gauge to make quick decisions as to the usefulness of a particular indicator and its settings.
For comparison, we’ll explore the following;
Daily – 1 year
4-hour – 3 months
The reason we don’t include exceptionally long (or short) testing periods is due to changing market conditions, which might return irrelevant information. A balance of statistically significant data is necessary for accurate results.
And the Outcome…
Below is a spreadsheet listing the results from our tests.
You can see that the green highlighted rows represent the best settings for that time frame when all the indicator settings have been taken into consideration. Please keep in mind that this changes over time and should not be considered specific trading advice.
For those who are curious as to what money management we’re using on our tests; we’re only using a stop loss of 1.5 x ATR and take profit of 1 x ATR. We’re only determining how well the indicator reacts to price with respect to generating a long or short signal. Your system, with its risk profile, will dictate individual returns. The stop loss and take profit levels are based on the No Nonsense Forex methodology, which can be found in the Advanced Course by clicking HERE.
As we did with previous indicator studies, we’ve made the ADX indicator available for download on our site from the indicator library, if for whatever reason you don’t have it on your platform. We will keep adding better indicators with each study for your use, at no charge. When you’re ready to get it, click HERE.
More to Come
There’s a lot more to come. If you haven’t signed up on our contacts page or subscribed to the YouTube channel, please consider doing so to receive notifications as we continue to publish helpful, relevant, and informative Forex related material to support your quest to becoming a better trader.
And now, you may be aware of an older indicator that is now more efficient. There are newer ones which we will explore in future blogs and videos. Stay tuned!
Our only goal is to make you a better trader.
BTW – Any information communicated by Stonehill Forex Limited is solely for educational purposes. The information contained within the courses and on the website neither constitutes investment advice nor a general recommendation on investments. It is not intended to be and should not be interpreted as investment advice or a general recommendation on investment. Any person who places trades, orders or makes other types of trades and investments etc. is responsible for their own investment decisions and does so at their own risk. It is recommended that any person taking investment decisions consults with an independent financial advisor. Stonehill Forex Limited training courses and blogs are for educational purposes only, not a financial advisory service, and does not give financial advice or make general recommendations on investment.