Trading in the volatile world of cryptocurrency necessitates a structured approach and well-planned strategy. Since cryptocurrencies typically have a low correlation to economic fundamental data and other markets, technical analysis and crypto-specific news remain the main drivers for analyzing cryptos.
Most analysts would agree that there is no “perfect” trading strategy. However, there are many methods that are well suited to those interested in trading cryptocurrencies. You simply need to pick out the strategy best suited for the market direction and your trading style.
Today we will be covering crypto trading strategy based on the combination of the Donchian Channel indicator and average directional movement index (ADX) indicator.
Understanding Donchian Channel indicator
Donchian Channel indicator is used for identifying the volatility of the cryptocurrency. This indicator is typically used to identify the breakout of crypto, enabling traders to take either long or short positions.
There are three bands in a Donchian Channel – upper band, middle band, and lower band and uses a default setting of 20-day. The upper band represents the highest price of the crypto over a 20-day period while the lower band represents the lowest price of the crypto over a 20-day period. The middle band is the average of the Upper and Lower band.
Donchian Channel
– Components
The channels are often used as a way to enter potentially emerging trends. Traders use the indicator to buy long when the price moves above the average line—or short-sell when the price falls below the average channel line.
During a clear uptrend, when the price pulls back to the lower band, traders go long. Similarly, traders short-sell during a clear downtrend, when the price rises to the upper band.
Understanding the ADX indicator
Average Directional Movement Index comprises of three lines: Minus Directional Indicator (-DI), ADX line, and Plus Directional Indicator (+DI). The ADX indicator calculates on the basis of moving average of price over a given time frame and is used for assessing the strength of a trend.
A crypto’s directional movement is determined by comparing the difference between two consecutive lows with the difference between their respective highs. (+DI) and (-DI) are derived from smoothed averages of these differences and measure trend direction over time.
ADX Indicator – Components
(+DI) and (-DI) are momentum indicators. (-DI) is the negative directional indicator while (+DI) is the positive directional indicator (+DI).
- When (+DI) is above (-DI), then the trend is considered as an uptrend.
- When (-DI) is above (+DI), then the trend is considered as a downtrend.
- (+DI) crossing over (-DI) signals trend reversal to a bullish trend.
- (-DI) is crossing over (+DI) signals trend reversal to a bearish trend.
ADX itself is the smoothed average of the difference of the (+DI) and (-DI) lines. ADX cannot have a negative value.
- When the value of ADX is <25, it indicates a weak trend
- When the value of ADX is between 25 and 50, it indicates a strong trend
- When the value of ADX is between 50 and 75, it indicates a very strong trend
- When the value of ADX is >75, it indicates an extremely strong trend
Crypto trading strategy based on Donchian Channel and ADX
Today’s crypto trading strategy focuses on using the Donchian Channel indicator in conjunction with the ADX indicator for accurate entry and exit.
Buying Rules
The buy signal is generated when the ADX reading is above 25 (this is because a value above 25 on the ADX line indicates a strong trend and a strong probability of a trend continuing), and the price touches the upper band of the Donchian Channel. Traders typically exit the trade once the price moves down from the middle band and touches the lower band of the Donchian Channel, and the ADX line falls below 25.
BTCUSD – Buy Criteria – Donchian Channel and ADX
As you can see from the chart of BTCUSD, the crypto started moving higher once the buy criteria were fulfilled.
Selling Rules
A sell signal is generated when the ADX reading is above 25 (this is because a value above 25 on the ADX line indicates a strong trend and a strong probability of a trend continuing), and the price moves down from the upper band and drops below the lower band of the Donchian Channel. Traders typically exit the trade once the price touches the upper band of the Donchian Channel and the ADX line falls below 25.
ETHUSD – Sell Criteria – Donchian Channel and ADX
As you can see from the chart of ETHUSD, the crypto started moving lower once the sell criteria were fulfilled.
As you can see, using the ADX indicator in conjunction with the Donchian Channel indicator can help you trade cryptos better, as their combination can help avoid false signals, creating profitable trading.
Happy trading!
Trades of the Day Research Team