Macd forex trading system
Moving average convergence divergence MACD , invented in by Gerald Appeal, is one of the most popular technical indicators in trading.
The MACD is appreciated by traders the world over for its simplicity and flexibility because it can be used either as a trend or momentum indicator. Trading divergence is a popular way to use the MACD histogram which we explain below , but unfortunately, the divergence trade is not very accurate as it fails more than it succeeds. To explore what may be a more logical method of trading the MACD divergence, we look at using the MACD histogram for both trade entry and trade exit signals instead of only entry , and how currency traders are uniquely positioned to take advantage of such a strategy.
An Overview The concept behind the MACD is fairly straightforward. Essentially, it calculates the difference between an instrument's day and day exponential moving averages EMA.
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Of the two moving averages that make up the MACD, the day EMA is obviously the faster one, while the day is slower. In the calculation of their values, both moving averages use the closing prices of whatever period is measured.
On the MACD chart, a nine-day EMA of the MACD itself is plotted as well, and it acts as a trigger for buy and sell decisions. The MACD generates a bullish signal when it moves above its own nine-day EMA, and it sends a sell sign when it moves below its nine-day EMA.
The MACD histogram is an elegant visual representation of the difference between the MACD and its nine-day EMA. The histogram is positive when the MACD is above its nine-day EMA and negative when the MACD is below its nine-day EMA.
If prices are rising, the histogram grows larger as the speed of the price movement accelerates, and contracts as price movement decelerates. The same principle works in reverse as prices are falling. See Figure 1 for a good example of a MACD histogram in action. The MACD histogram is the main reason why so many traders rely on this indicator to measure momentum , because it responds to the speed of price movement. Indeed, most traders use the MACD indicator more frequently to gauge the strength of the price move than to determine the direction of a trend.
Trading Divergence As we mentioned earlier, trading divergence is a classic way in which the MACD histogram is used. One of the most common setups is to find chart points at which price makes a new swing high or a new swing low , but the MACD histogram does not, indicating a divergence between price and momentum.
Figure 2 illustrates a typical divergence trade. Unfortunately, the divergence trade is not very accurate, as it fails more times than it succeeds. Prices frequently have several final bursts up or down that trigger stops and force traders out of position just before the move actually makes a sustained turn and the trade becomes profitable.
Figure 3 demonstrates a typical divergence fakeout , which has frustrated scores of traders over the years. One of the reasons that traders often lose with this set up is they enter a trade on a signal from the MACD indicator but exit it based on the move in price. Since the MACD histogram is a derivative of price and is not price itself, this approach is, in effect, the trading version of mixing apples and oranges.
Using the MACD Histogram for Both Entry and Exit To resolve the inconsistency between entry and exit , a trader can use the MACD histogram for both trade entry and trade exit signals. To do so, the trader trading the negative divergence takes a partial short position at the initial point of divergence, but instead of setting the stop at the nearest swing high based on price, he or she instead stops out the trade only if the high of the MACD histogram exceeds its previous swing high, indicating that momentum is actually accelerating and the trader is truly wrong on the trade.
If, on the other hand, the MACD histogram does not generate a new swing high, the trader then adds to his or her initial position, continually achieving a higher average price for the short.
Currency traders are uniquely positioned to take advantage of this strategy because with this strategy, the larger the position, the larger the potential gains once the price reverses; in Forex FX , you can implement this strategy with any size of position and not have to worry about influencing price. Traders can execute transactions as large as , units or as little as 1, units for the same typical spread of three-to-five points in the major pairs. In effect, this strategy requires the trader to average up as prices temporarily move against him or her.
This, however, is typically not considered a good strategy. Many trading books have derisively dubbed such a technique as " adding to your losers. In effect, the trader is trying to call the bluff between the seeming strength of immediate price action and the MACD readings that hint at weakness ahead.
Still, a well-prepared trader using the advantages of fixed costs in FX, by properly averaging up the trade, can withstand the temporary drawdowns until price turns in his or her favor. Figure 4 illustrates this strategy in action. Like life, trading is rarely black and white.
Some rules that traders agree on blindly, such as never adding to a loser, can be successfully broken to achieve extraordinary profits. However, a logical, methodical approach for violating these important money management rules needs to be established before attempting to capture gains. In the case of the MACD histogram, trading the indicator instead of the price offers a new way to trade an old idea - divergence. Applying this method to the FX market, which allows effortless scaling up of positions, makes this idea even more intriguing to day traders and position traders alike.
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Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. Trading The MACD Divergence By Boris Schlossberg Updated January 16, — 6: As price action top part of the screen accelerates to the downside, the MACD histogram in the lower part of the screen makes new lows Source: FXTrek Intellicharts The MACD histogram is the main reason why so many traders rely on this indicator to measure momentum , because it responds to the speed of price movement.
A typical negative divergence trade using a MACD histogram. At the right-hand circle on the price chart, the price movements make a new swing high, but at the corresponding circled point on the MACD histogram, the MACD histogram is unable to exceed its previous high of 0.
The histogram reached this high at the point indicated by the lower left-hand circle. The divergence is a signal that the price is about to reverse at the new high, and as such, it is a signal for the trader to enter into a short position. FXTrek Intellicharts Unfortunately, the divergence trade is not very accurate, as it fails more times than it succeeds. A typical divergence fakeout. Strong divergence is illustrated by the right circle at the bottom of the chart by the vertical line, but traders who set their stops at swing highs would have been taken out of the trade before it turned in their direction.
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FXTrek Intellicharts One of the reasons that traders often lose with this set up is they enter a trade on a signal from the MACD indicator but exit it based on the move in price. The chart indicates where price makes successive highs but the MACD histogram does not - foreshadowing the decline that eventually comes.
By averaging up his or her short, the trader eventually earns a handsome profit as we see the price making a sustained reversal after the final point of divergence. FXTrek Intellicharts Like life, trading is rarely black and white.
Using the simple MACD histogram could change how forex traders analyze currency pairs for good. Two indicators are usually better than one. Find out how this pairing can enhance your trading. This type of strategy demands controlled decision-making, requiring a continual refinement of entry and exit techniques.
These stocks are exhibiting bearish crossovers in their MACD readings, indicating potential short-term weakness, but also longer-term buying opportunities. MACD divergence is a popular method for predicting reversals, but unfortunately it isn't very accurate.
Learn the weaknesses of indicator divergence. Learn how this momentum indicator is used to determine price action on a stock. Learn the best technical indicators to use as part of a trading strategy in conjunction with the moving average convergence Consider some forex trading strategies that can be designed using the exponential moving average EMA lines on the moving Discover common divergence strategies that utilize either stochastics or the MACD, the two most frequently used momentum Learn some common trading strategies that traders employ using the moving average convergence divergence MACD technical Explore two frequently used momentum indicators in forex trading, the moving average convergence divergence, or MACD, and Find out why the moving average convergence divergence MACD oscillator is considered one of the simplest, most versatile An expense ratio is determined through an annual A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies.
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Get Free Newsletters Newsletters. All Rights Reserved Terms Of Use Privacy Policy. As price action top part of the screen accelerates to the downside, the MACD histogram in the lower part of the screen makes new lows.