Day Trading & Forex Forum

In case of an existing uptrend, the DI+ line would signs of flattening and then cross the ADX line (which could still be rising). The confirmation of the change of trend to the downside would come only when the ADX starts declining. This would be followed by the DI+ line crossing the DI- line down.

Similarly in case of an existing downtrend, the DI- line would signs of flattening and then cross the ADX line (which could still be rising). The confirmation of the change of trend to the upside would come only when the ADX starts declining. This would be followed by the DI- line crossing the DI+ line down.

This use of the ADX for the exits is called the "turning-point" concept.
The relationship of the three lines with the ADX being the highest tells us that there has been an extended price move which is running out of momentum.

If we apply our rules to our example here –

• We will consider an entry only at this point marked ‘A’, when the ADX has started rising.
• We consider exiting the trade, only when the plus DMI has reached an extreme level, and the ADX is turning down at this point.

Even though this is a high probability setup, we can use an additional confirmation factor, since there is some lag in decline of the ADX line, and the subsequent crossover of the DI+/DI- lines.

A lot of times, the crossover and the decline of the ADX occur much after the price has moved a considerable distance in the direction of the changed trend, and hence some profits in the new direction may have been missed.

With the intention of reducing this lag, and the idea that there would be room for further improvement, it was found that the PSAR provided much more timely entry triggers.

PSAR
The Parabolic SAR (Stop And Reverse) was developed by J. Welles Wilder Jr. and is primarily used in trending markets. Wilder recommended establishing the trend first, and then trading with Parabolic SAR in the direction of the trend.

The Parabolic SAR allows the trader to follow the dots in an upward or downward trend, until the trend reverses. Thus it is also called a reversal system, and is more popular for setting stops than for establishing direction or trend.

Interpretation -

• If the trend is up, buy when the SAR moves below the price. This will be the stop level below the current price, which will move up every day until activated (when price falls to the stop level).  
• If the trend is down, sell when the SAR moves above the price. This will be the stop level above the current price, which will move down every day until activated (when price rises to the stop level). 

The concept is that as the price rises, the dots will rise as well, first slowly and then picking up speed and accelerating with the trend. The SAR starts to move a little faster as the trend develops and the dots soon catch up to the price action. This is what we call as activating the stop level, and is taken as a signal to exit the long position.

Drawbacks –

• Although it works extremely well in markets with a dominant trend, it fails miserably in horizontal or choppy markets. 
• If and when prices do not develop consistent trends, it creates a jerky SAR which makes it difficult to enter and exit.