Indicators are crucial for the on chart analysis of currencies. One of the most popular tools for technical analysis in Forex is the MACD indicator. This is so due to the success. This article will give you an in depth review of the Moving Average Convergence Divergence indicator. Then you will be able to apply it raw on your charts or to assist your current Forex trading system. In any case, the MACD indicator strategy can only improve your trading approach.
What is MACD Indicator in Forex
The MACD is one of the most used Forex indicators for technical analysis. The indicator consists of two lines on an area and a histogram.
Above you see a zoom-in image of the MACD Forex indicator that shows the way it will look like at the bottom of your chart.
The MACD indicator trading strategy involves making trading decisions based on signals that come from the indicator. The indicator is helpful in recognizing potential price increases and decreases. Traders use the MACD indicator Forex tool to support their Forex strategy and to open trades based on signals.
What is the MACD Definition
MACD is an abbreviation of Moving Average Convergence Divergence. The indicator was developed in 1970 by Gerald Appel to signalize changes in the direction, momentum and the strength of the Forex trends. MACD is a lagging indicator, which means that its signals appear after the event has begun on the chart. In this relation, the tool has trend-confirming character.
Default MACD Indicator Settings for Day Trading
The default MACD settings suggest the usage of two lines and a histogram placed on an area. We will go through each of these elements explaining the Moving Average Convergence Divergence formula. But let’s first have a quick look at the three components of the instrument:
The blue line is called an MACD Line. The red line is the Signal Line. And the bars in the middle of the indicator represent a histogram.
MACD Line Calculation
The most important component of the indicator is the MACD line. This is the faster line of the indicator. The calculation of this line involves two Exponential Moving Averages – a 12-period EMA and a 26-period EMA. The MACD line represents the difference between the two EMAs:
MACD line = 12 EMA – 26 EMA
MACD Signal Line Calculation
The slower line of the MACD indicator calculation is called a signal line. It involves the usage of another Exponential Moving Average. The truth is that the MACD signal line is a 9-period EMA of the MACD line.
Signal Line = 9-period EMA of MACD line
MACD Histogram Explained
MACD histogram calculation is a visualized difference between the two lines of the indicator. This means that you need to subtract the two lines to get the value of the MACD histogram.
MACD Histogram = MACD Line – Signal Line
How to Read MACD Indicator
Now let’s discuss the general MACD indicator how-to-use guide. The tool involves three major signal groups, and we will now go through each one of them.
The MACD crossover is the most popular signal related to the indicator. It involves the intersection of the two lines. In this relation, we recognize two types of MACD crossover:
Bullish MACD Crossover – It comes when the MACD line crosses the Signal Line in the bullish direction. This signal alerts that the price of the Forex pair is likely to increase.
Bearish MACD Crossover – It comes when the MACD line crosses the Signal Line in a bearish direction. The bearish MACD cross indicates that the price of the Forex pair is likely to decrease.
The MACD analysis involves the recognition of divergence as well. In this relation, there are two types of MACD divergence in Forex – bullish and bearish divergence.
Bullish MACD Divergence – When the bottoms of the price action are decreasing, but the bottoms of the MACD are increasing, we have a bullish divergence. It signalizes that the Forex pair is about to do a bullish run.
Bearish MACD Divergence – When the tops of the price action are increasing, while the tops of the MACD are decreasing, we have a bearish divergence. It indicates that the price might drop on the chart.
Now I will show you an example of a trade I did with the MACD indicator. The video below shows a bullish MACD divergence that I used to open a long trade with the USD/CAD Forex pair. Also, the video shows how to successfully combine the Forex MACD with price action rules. The video includes signals from a Falling Wedge chart pattern.
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Bottom line, the bullish MACD trade you just saw generated 16 pips, which equals to 0.11% profit for my account!
Although many traders are not familiar with this, you should know that the MACD trading indicator also gives signals that the Forex pair is overbought or oversold. Although the indicator does not have specific zones indicating the two sectors, you can identify the overbought/oversold Forex pair by comparing the current MACD value to previous values.
Overbought MACD – The indicator gives an overbought signal when you notice the two lines being relatively high compared to previous highs. At the same time, the sell signal appears when the MACD line creates a sharp bearish move crossing the Signal Line.
Oversold MACD – The indicator gives an oversold signal whey you see the two lines being at a relative low compared to previous bottoms. The buy signal appears if the MACD line creates a sharp bullish move through the Signal Line.
If you experience difficulties in recognizing the sharp switch of the MACD line, there is a quick fix to this problem. Refer to the MACD histogram to identify unusually big bars. Don’t forget that the histogram shows the difference between the MACD Line and the Signal Line.
How to Use the MACD Indicator in Forex
Now I will show you two basic ways to recognize signals with the MACD indicator. We will start with the classical way of trading with the Moving Average Convergence Divergence indicator.
Classical MACD Indicator Tutorial
The classical way of the MACD trading involves the usage of the crossover, the divergence, and the overbought/oversold indications. The image below will give you a better picture about this:
This is the H4 chart of the EUR/USD for April – May 2016. You see five different MACD signals on the image.
The first signal comes with the first green circle on the indicator – a bullish crossover. The EUR/USD price is increasing afterward. The second signal is a bearish crossover that leads to a price decrease.
The third signal is a bit more special. The reason for this is that the third green circle points to the confirmation of two MACD signals. The first signal is an obvious bullish crossover. The second signal comes with the formation of the second MACD bottom that is increasing. But at the same time, we see that the second price action bottom is decreasing. This confirms the presence of a bullish divergence on the chart. The EUR/USD price enters a strong uptrend afterward.
The last signal comes at the end of the price increase. Although it looks like a standard bearish MACD crossover, there is something more in this signal. Notice that the two MACD lines are relatively high in the indicator area. At the same time, the MACD line creates a sharp change in its direction, gaining distance from the Signal Line. In the red circle, you will see that the change in the direction of the MACD line is so sharp, that there is like a corner curve on the line. This could be taken as a signal that the EUR/USD is overbought.
MACD Histogram Trading Strategy
The next trading strategy we will discuss involves the usage of the MACD histogram. This indicator approach doesn’t even require the usage of the two indicator lines.
You should follow the histogram for consistent price increases/decreases. The signals of the MACD histogram strategy come when you see a bar that is opposite to the general histogram direction. Notice that this strategy is more successful on smaller chart time frames due to the bigger candle shifts.
Above you see the 5-minute chart of the EUR/USD. Notice that I have increased the size of the MACD indicator so that the bars will be bigger and easier to read. The purple lines on the Moving Average Convergence Divergence histogram indicate changes in the histogram trend. The green circles show the respective signals. As you see, the price of the EUR/USD creates the respective moves after the signal is received.
The MACD histogram trading strategy is a way to use the MACD as a leading indicator by receive earlier signals. See that the histogram signals appear prior the actual MACD crossover. This is why this strategy is good for making early entries in the market. However, the false signals of this trading strategy are likely to be more. In this relation, it would be better if you use an additional indicator to confirm your entries on the chart. Another oscillator like the Stochastic might be a good tool for your MACD histogram system.
Also, notice that the MACD histogram strategy does not involve the usage of the lines. You can totally remove the two lines if you rely only on the histogram. However, I will advise you not to do so. After all, it is not a bad thing to have additional signal providers on your indicator.
Trading Examples of MACD Technical Analysis
Now let’s suggest some trades using the MACD Forex indicator. We will discuss the three MACD trading strategies every Forex trader should know in details.
Crossover MACD Trading
The example below will show you couple trades based on MACD crossover signals. This is a basic MACD approach that every trader should know. You should simply open a trade when an MACD cross appears and hold the trade until an opposite cross occurs.
The chart you are looking at is H1 of the USD/JPY for Feb 28 – Mar 2, 2017.
The first signal appears when the MACD line breaks the Signal Line downward. You should sell the USD/JPY at this time, placing a Stop Loss order above a visible top prior your entry point. Then you should hold the trade until an opposite cross occurs on the chart.
Yes, but this opposite cross plays the role of another entry point on the chart. The cross is bullish, and you need to close your short trade and open another trade that is bullish. Your Stop Loss order should be located below a visible bottom on the chart as shown on the image. The trade should be held until you see opposite MACD crossover.
The interesting here is that we use MACD cross to exit our trades. Yes, but we still use a Stop Loss order. Why is that? The thing is that the Stop is not meant to be hit. It is there to protect you from sharp and volatile price moves. You will rarely close an MACD trade on a Stop Loss hit. However, it should still be there.
Divergence MACD Trading
The next Moving Average Convergence Divergence analysis involves the usage of Divergence. The point of this strategy is to spot a bullish or a bearish divergence and to trade it. Your entry point on the chart should be taken based on the crossover at the second top/bottom of the MACD divergence. Then you should hold the trade until the MACD creates an opposite cross.
Now let’s proceed to the example:
This is the H1 chart of the EUR/USD for Sep 22 – 28, 2016. Below you see the MACD 2 line indicator again.
Notice that the two big tops at the indicator are decreasing, while the two tops on the chart are increasing. This is an obvious bearish divergence between the price action and the MACD. You should short the EUR/USD at the bearish crossover when the second MACD top is created. Place your Stop Loss order above the created chart top. Then you should hold the until the opposite MACD crossover.
Histogram MACD Trading
Now let’s discuss in details how to open and close trades based on the MACD histogram trading strategy. You should open a trade immediately when you notice a histogram bar closing contrary to the general histogram trend. Then you should hold your trade when you receive the opposite signal from the histogram.
See the example below:
This time we approach a smaller EUR/USD chart – M15. The image illustrates three trades taken based on the MACD histogram.
The first trade is short, and it comes when one of the histogram bars closes lower. You should sell placing a Stop Loss above the created top. The price decreases and you should close the trade when the histogram creates the exactly opposite thing. This happens in the first Close/Buy rectangle on the indicator.
You should exit the short trade and open a long trade placing a Stop below the created bottom. Same happens 12 periods later. The histogram starts increasing creating higher bars. However, 12 bars later we see a bar that closes lower. This is shown in the Close/Sell rectangle.
You exit the long trade and open a short one placing a Stop Loss above the already created top. Then you hold the trade until the histogram closes a higher bar.
- MACD is one of the most used technical indicators in Forex.
- MACD stays for Moving Average Convergence Divergence.
- The indicator consists of two lines and a histogram.
- It falls into the category of the leading indicators and has trend confirming character.
- The Moving Average Convergence Divergence formula concerns three components:
- MACD Line = 12 EMA – 26 EMA
- Signal Line = 9 EMA of the MACD Line
- MACD Histogram = MACD Line – Signal Line
- There are three basic signal types related to the MACD Forex indicator:
- MACD Crossovers: Bullish and Bearish MACD Cross
- MACD Divergence: Bullish and Bearish MACD Divergence
- Overbought and Oversold MACD Signals
- MACD Crossover Strategy:
- Open trades on crosses of the MACD lines.
- Enter in the direction of the crossover.
- Stay until you see opposite MACD cross.
- MACD Divergence Strategy
- Buy on the second cross when the MACD bottoms are increasing, and the price bottoms are decreasing.
- Exit when you see opposite MACD crossover.
- Sell on the second cross when the MACD tops are decreasing, and the price tops are increasing.
- Exit when you see opposite MACD crossover.
- MACD Histogram Strategy
- Open when you see a histogram bar that is opposite to the general histogram trend.
- Stay in the trade until you see the exactly opposite event.
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- Forex indicators
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