Trading with MACD – Simple Effective Strategies Explained

The MACD is one of the most popular and broadly used indicators for Forex trading. The letters M.A.C.D. is abbreviation for Moving Average Convergence Divergence. The MACD indicator, which requires Moving Averages as its input, falls into the group of the lagging indicators.

The basic function of the MACD Forex indicator is to discover new trends and to help identify the end of current trends. There are various ways to gauge the signals generated by MACD, and many traders use their own unique settings and methods around this trading indicator.

Understanding the MACD Indicator

The MACD indicator is typically placed at the bottom of the trading chart, in a separate window, beneath the price chart. The Moving Average Convergence Divergence is a relatively easy-to-use tool, however, it is crucial to understand it fully before attempting to trade using its signals. Let’s take a close look at the structure of the MACD indicator and its default settings.

MACD Structure

The MACD indicator consists of three components. There are two lines and a histogram. Let’s now discuss each of these separately:

  • MACD Line – The MACD line is the faster line on the indicator. Since it reacts faster it and is more sensitive, it generally moves above and below the second line of the indicator.
  • MACD Signal Line – The MACD signal line is the second line of the MACD indicator. It is called a signal line, because it generates the basic MACD signals. Since the line is slower, it gets frequently breached by the faster MACD line.
  • MACD Histogram – The MACD histogram simply represents the difference between the MACD line and the signal line. The bigger the gap between the lines, the higher the bars that the MACD histogram will display.

Below you will see an example of the MACD indicator:

This is a zoomed image of the MACD indicator. The blue line is the MACD line. The red line is the signal line. As you see, the MACD line is faster and it often breaks the signal line. The gray bars are the histogram, which move in harmony with the distance between the two lines of the indicator.

MACD Settings

On most trading platforms, the MACD indicator typically comes with the default parameters 26, 12, and 9. We will interpret the meaning of these three numbers and how they apply to the structure of the indicator.

The “12” and “26” are mutually related. These two numbers concern the calculation of the faster MACD line. The structure of the MACD line comes with calculating a 12-period Exponential Moving Average on the price action and then subtracting a 26-period Exponential Moving Average from the result. The difference between the two EMAs gives you the value of the faster line.

The “9” comes from the calculation of the slower line a.k.a. the signal line. This line is a product of a 9-period Exponential Moving Average plotted on the faster MACD line. This is why the signal line is slower than the MACD line – because it is the smoother version of the MACD line.

MACD Signals

Although the MACD indicator consists only of three components (the two lines and the histogram) it can provide a myriad of signals. We recognize six basic signals of the MACD and now we will discuss each of these separately.

MACD Crossovers

The MACD crossovers involve the interaction between the two MACD lines. The MACD line is faster than the signal line, and it will typically cross above and below the slower signal line.

  • Bullish MACD Crossover – We have a bullish MACD crossover when the MACD line crosses the slower signal line in the bullish direction. This action generates a bullish signal on the chart, which implies that the price might start an increase.
  • Bearish MACD Crossover – The bearish MACD crossover is opposite to the bullish MACD crossover. When the MACD line crosses the signal line in the bearish direction, we have a bearish crossover. This hints that the price action might be entering a bearish move.TO BE CONTINUE…

A Simple MACD Strategy

It can be extremely difficult for new traders to finalize a trading strategy for trading the Forex market. The options for market entry are virtually unlimited, and it is often good to have a simple strategy on standby. Today we are going to review the basics of a simple MACD strategy, based on finding the trend then utilizing an indicator for execution.

So let’s get started!

Find the Trend

The first step to trading any successful trend based strategy is to find the trend! One of easiest ways to find the trend is through the drawing of a trendline. Traders can connect the lows in an uptrend and find a clear area of where price is supported. Below we can find an ascending trendline on the EURCAD.

Given the information above, traders should look to buy the EURCAD as long as it remains supported. If the trend continues, expectations are that price will remain above support and new highs will be created.

Learn Forex –EURCAD Trendline

MACD Entry

Once a trendline is drawn, and a trading bias has been established traders will begin looking for areas to enter new positions. One of the easiest ways to find a technical trigger is through the use of an indicator. Below we can see the EURCAD daily graph, this time with MACD added. Since we have identified the EURCAD in an uptrend traders will look to buy when the MACD when momentum returns to the underlying currency pair. This occurs whenthe Red MACD line to crossover the Blue Signal line, prior to executing their orders.

Below you will find several examples of past MACD crossoverson the EURCAD. Note how only buy positions are to be taken on bullish crossovers as the uptrend continues.

Learn Forex – EURUSD & CCI

Manage Risk

When trading markets, there will always be a degree of risk. When trading trends, it is important to know that they will eventually come to an end. In an uptrend like the EURCAD, traders may place stops under the established line of trendline support. In the event that price breaks under support, traders will wish to exit any existing positions and look for other opportunities.

—Written by Walker England, Trading Instructor

To contact Walker, email instructor@dailyfx.com. Follow me on Twitter @WEnglandFX.

To be added to Walker’s e-mail distribution list, CLICK HERE and enter in your email information.

Don’t Trade Based on MACD Divergence Until You Read This

The MACD–moving average convergence divergence–indicator is popular among traders and analysts, yet few really understand it. Divergence on the MACD is one of the ways the indicator is used, and takes two forms. When the price of an asset is moving one direction and the MACD in the other, that’s divergence. This type of signal is supposed to warn of a reversal, but as discussed below, the signal is random and often inaccurate.

Another type of divergence is when the price makes a new high (or new low) but the MACD doesn’t. Traditionally this indicates the price is losing momentum and prime pickings for a reversal. This also tends to be a very poor trading signal.

By understanding the MACD a little more, you’ll understand how it actually works so you don’t get fooled by its common false signals or lack of signals (when the price turns but the MACD doesn’t provide warning).

Problems With Divergence After a Sharp Move

Without going into the math of the indicator, monitoring the MACD in relation to price action reveals a few problems which could affect the MACD-divergence trader.

Note: If trading with a technical indicator, any indicator, be aware of exactly how it functions, so you know all of its drawbacks and benefits.

Divergence will almost always occur right after a sharp price move higher (or lower). Determining whether a price move is sharp (or slow, or large or small) requires looking at the velocity and magnitude of the price moves around it. The price momentum can’t continue forever so as soon as the price begins to level off, the MACD will diverge (for example, go up, even if the price is still dropping).

After a strong price rally MACD divergence isn’t useful. By dropping, while the price continues to move higher or move sideways, the MACD is showing momentum has slowed…but it doesn’t indicate a reversal.

In the attached chart (click here for larger version) the EURUSD is falling, yet the MACD is rising. Had a trader assumed that the rising MACD was a positive sign, they may have exited their short trade, missing out on additional profit. Or they may have taken a long trade, even though the price action showed a significant downtrend and no signs of a reversal (no higher swing highs or higher swing lows to indicate an end to the downtrend).

That doesn’t mean divergence can’t or won’t signal the occasional reversal, but it must be taken with a grain of salt after a big move. Since divergence occurs after almost every big move, and most big moves aren’t immediately reversed right after, if you assume that divergence (in this case) means a reversal is coming, you could get yourself into a lot of losing trades.

Problems with Divergence Between MACD Highs (or Lows)

Traders also compare prior highs on the MACD with current highs, or prior lows with current lows. For example, if the price moves above a prior high, traders will watch for the MACD to also move above its prior high. If it doesn’t, that’s a divergence–a traditional warning signal of a reversal.

This is also fallible, and related to the problem discussed above. A lower MACD high simply shows the price didn’t have the same velocity it had last time it moved higher (it may have moved less, or it may have moved slower), but that doesn’t indicate a reversal.

As discussed above, a sharp price move will cause a large move in the MACD, larger than what is caused by slower price moves.

An asset can march higher or lower, slowly, for very long periods of time. If this occurs after a steeper move (more distance covered in less time) then the MACD will show divergence for much of the time the price is slowly (relative to the prior sharp move) marching higher.

If a trader assumes a lower MACD high means the price will reverse, a valuable opportunity may be missed to stay long and collect more profit from the slow(er) march higher. Or worse, the trader may take a short position into a strong uptrend, with little evidence to support the trade except an indicator which isn’t useful in this situation (see: Probabilities in Trading).

The attached chart (click here for larger version) shows a downtrend in APPL stock. The downtrend is caused by sharp downward moves, followed by slower downward moves. The sharp price moves always cause much bigger downdrafts in the MACD than slower price moves. This results in divergence when the next price wave isn’t as sharp, but in no way indicates a reversal. MACD divergence was present this whole day, yet the price dropped all day. If monitoring divergence, an entire of day of profits on the downside would have been missed.

Another problem with watching for this type of divergence is that it often isn’t present when an actual price reversal occurs. Therefore, we have an indicator which provides many false signals (divergence occurs but price doesn’t reverse), but also fails to provide signals on many actual price reversals (price reverses when there is no divergence).

Ultimate Guide to the MACD Indicator

Technical analysis indicators condense price information, providing analytical insight and trading signals which may not be obvious on a stock’s price chart. The Moving-Average-Convergence-Divergence (MACD) indicator fluctuates above and below zero, highlighting both the momentum and trend direction of a stock. Utilizing the MACD effectively requires understanding how it works, its functions and applications, as well as its limitations.

What is the MACD Indicator?

Gerald Appel developed the MACD in the 1970s, and it is one of the most popular indicators in use today. Traders use the MACD for determining trend direction, momentum and potential reversals. It is used to confirm trades based on other strategies, but it also provides its own trade signals.

Figure 1 shows the MACD applied to a daily chart of Apple (AAPL) stock.

Two lines compose the MACD: the MACD line and Signal line. These lines move together, except the MACD moves faster as the Signal line is a moving average of the MACD line.

The MACD Histogram that oscillates above and below zero shows the extent to which the MACD line is above or below signal line. The histogram provides a short-term view on recent momentum and direction. When the histogram is above zero, recent movement has been higher; below zero and the recent momentum was down. The greater the histogram value the greater the momentum of the recent move.

The Histogram is not always shown as part of the MACD indicator as many traders prefer to focus on the how the two lines (MACD and Signal) are interacting. These two lines are the source of most MACD strategies and price analysis.

The MACD is calculated as follows:

MACD Line = 12day EMA – 26day EMA
Signal Line = 9day EMA of MACD Line

EMA stands for exponential moving average.

The MACD Histogram is the MACD Line – Signal Line

Trading with the MACD Indicator

There are three primary uses for the MACD indicator, each offering advantages and disadvantages. Combing all three functions will help eliminate some losing MACD trade signals, as will using the MACD in conjunction with other indicators and price analysis.

Zero-Line Crossovers

Moves across the zero line on the indicator represent times when the 12day EMA is crossing the 26day EMA. When the MACD crosses the zero line from below, a new uptrend may be emerging. When the MACD crosses the zero line from above a new downtrend may be emerging.

Figure 2 shows several zero line crossovers in International Business Machines (IBM).

The strategy is to buy when the MACD crosses above the zero line, and sell (or take short positions) when the MACD line (black) crosses below the zero line. During choppy conditions this results in losing trades, and is profitable when strong trends emerge.

Hold long trades until the MACD crosses back below the zero line. Hold short trades until the MACD crosses above the zero line. This strategy is very basic and doesn’t have a stop loss, which means risk is not controlled. To utilize this strategy, traders need to implement their own form of risk control (see next section)

Zero line crossovers also confirm trends. When the MACD line is above zero it helps confirm uptrends and other strategies that indicate taking long positions. Below zero, the MACD confirms downtrends and taking short trades based on other strategies.

Signal Line Crossovers

Signal line crossovers provide better timing, and are preferred by most traders to zero-line crossovers.

With this method, a buy signal occurs when the MACD line crosses above the Signal line.

A sell (short) signal occurs when the MACD line crosses below the Signal line. Figure 3 shows IBM again, this time using Signal line crossovers. The buy and sell signals occur earlier in the price move than zero-line crossovers, potentially providing better entry and exit prices.

Since the MACD is an indicator, and not a trading system, there is no stop loss. For buy signals a stop can be placed below a recent low, and for short signals a stop can be placed above the recent high.

There are no built in targets, so trades are held until a crossover in the opposite direction occurs. New trades can then be initiated in the new crossover direction.

The downfall of this strategy is that it can result in “whipsaw” trades, when the MACD and Signal lines cross back and forth in a short amount time.

One way to avoid some whipsaws is to only take trades in the direction of the long-term trend. If the trend is up, only take a buy signals, and exit when the MACD line crosses back below the Signal Line.

Divergence

Bearish divergence is when the price is making new highs, but the MACD isn’t. It shows that momentum has slowed, and a reversal could be forthcoming.

Bullish divergence is when the price is making new lows, but the MACD isn’t. It shows selling pressure has slowed, and a reversal higher could be around the corner.

Until divergence is confirmed by an actual turnaround in price, don’t base trades simply on divergence. A stock can continue to rise (fall) for a long time even while bearish (bullish) divergence is occurring.

MACD And Stochastic: A Double-Cross Strategy

Ask any technical trader and he or she will tell you that the right indicator is needed to effectively determine a change of course in a stocks’ price patterns. But anything that one “right” indicator can do to help a trader, two complimentary indicators can do better. This article aims to encourage traders to look for and identify a simultaneous bullish MACD crossover along with a bullish stochastic crossover and then use this as the entry point to trade.

Pairing the Stochastic and MACD
Looking for two popular indicators that work well together resulted in this pairing of the stochastic oscillator and the moving average convergence divergence (MACD). This team works because the stochastic is comparing a stock’s closing price to its price range over a certain period of time, while the MACD is the formation of two moving averages diverging from and converging with each other. This dynamic combination is highly effective if used to its fullest potential. (For background reading on each of these indicators, see Getting To Know Oscillators: Stochastics and A Primer On The MACD.)

Working the Stochastic 
There are two components to the stochastic oscillator: the %K and the %D. The %K is the main line indicating the number of time periods, and the %D is the moving average of the %K.

Understanding how the stochastic is formed is one thing, but knowing how it will react in different situations is more important. For instance:

  • Common triggers occur when the %K line drops below 20 – the stock is considered oversold, and it is a buying signal.
  • If the %K peaks just below 100, then heads downward, the stock should be sold before that value drops below 80.
  • Generally, if the %K value rises above the %D, then a buy signal is indicated by this crossover, provided the values are under 80. If they are above this value, the security is considered overbought.

Working the MACD
As a versatile trading tool that can reveal price momentum, the MACD is also useful in the identification of price trend and direction. The MACD indicator has enough strength to stand alone, but its predictive function is not absolute. Used with another indicator, the MACD can really ramp up the trader’s advantage. (Learn more about momentum trading in Momentum Trading With Discipline.)

If a trader needs to determine trend strength and direction of a stock, overlaying its moving average lines onto the MACD histogram is very useful. The MACD can also be viewed as a histogram alone. (Learn more in An Introduction To The MACD Histogram.)

 

MACD Calculation 
To bring in this oscillating indicator that fluctuates above and below zero, a simple MACD calculation is required. By subtracting the 26-day exponential moving average (EMA) of a security’s price from a 12-day moving average of its price, an oscillating indicator value comes into play. Once a trigger line (the nine-day EMA) is added, the comparison of the two creates a trading picture. If the MACD value is higher than the nine-day EMA, then it is considered a bullish moving average crossover.

It’s helpful to note that there are a few well-known ways to use the MACD:

  • Foremost is the watching for divergences or a crossover of the center line of the histogram; the MACD illustrates buy opportunities above zero and sell opportunities below.
  • Another is noting the moving average line crossovers and their relationship to the center line. (For more, see Trading The MACD Divergence.)

Identifying and Integrating Bullish Crossovers
To be able to establish how to integrate a bullish MACD crossover and a bullish stochastic crossover into a trend-confirmation strategy, the word “bullish” needs to be explained. In the simplest of terms, “bullish” refers to a strong signal for continuously rising prices. A bullish signal is what happens when a faster moving average crosses up over a slower moving average, creating market momentum and suggesting further price increases.

  • In the case of a bullish MACD, this will occur when the histogram value is above the equilibrium line, and also when the MACD line is of a greater value than the nine-day EMA, also called the “MACD signal line.”
  • The stochastic’s bullish divergence occurs when %K value passes the %D, confirming a likely price turnaround.

Crossovers In Action: Genesee & Wyoming Inc. (NYSE:GWR)
Below is an example of how and when to use a stochastic and MACD double cross.

Note the green lines that show when these two indicators moved in sync and the near-perfect cross shown at the right-hand side of the chart.

You may notice that there are a couple of instances when the MACD and the stochastics are close to crossing simultaneously – January 2008, mid-March and mid-April, for example. It even looks like they did cross at the same time on a chart of this size, but when you take a closer look, you’ll find that they did not actually cross within two days of each other, which was the criterion for setting up this scan. You may want to change the criteria so that you include crosses that occur within a wider time frame, so that you can capture moves like the ones shown below.

It’s important to understand that changing the settings parameters can help produce a prolonged trendline, which helps a trader avoid a whipsaw. This is accomplished by using higher values in the interval/time-period settings. This is commonly referred to as “smoothing things out.” Active traders, of course, use much shorter time frames in their indicator settings and would reference a five-day chart instead of one with months or years of price history.

The Strategy
First, look for the bullish crossovers to occur within two days of each other. Keep in mind that when applying the stochastic and MACD double-cross strategy, ideally the crossover occurs below the 50 line on the stochastic to catch a longer price move. And preferably, you want the histogram value to be or move higher than zero within two days of placing your trade.

Also note that the MACD must cross slightly after the stochastic, as the alternative could create a false indication of the price trend or place you in sideways trend.

Finally, it is safer to trade stocks that are trading above their 200-day moving averages, but it is not an absolute necessity.

The Advantage
This strategy gives traders an opportunity to hold out for a better entry point on uptrending stock or to be surer that any downtrend is truly reversing itself when bottom-fishing for long-term holds. This strategy can be turned into a scan where charting software permits.

The Disadvantage 
With every advantage that any strategy presents, there is always a disadvantage to the technique. Because the stock generally takes a longer time to line up in the best buying position, the actual trading of the stock occurs less frequently, so you may need a larger basket of stocks to watch.

Trick of the Trade
The stochastic and MACD double cross allows for the trader to change the intervals, finding optimal and consistent entry points. This way it can be adjusted for the needs of both active traders and investors. Experiment with both indicator intervals and you will see how the crossovers will line up differently, and then choose the number of days that work best for your trading style. You may also want to add an RSI indicator into the mix, just for fun. (Read Ride The RSI Rollercoaster for more on this indicator.)

Conclusion
Separately, the stochastic oscillator and MACD function on different technical premises and work alone. Compared to the stochastic, which ignores market jolts, the MACD is a more reliable option as a sole trading indicator. However, just like two heads, two indicators are usually better than one! The stochastic and MACD are an ideal pairing and can provide for an enhanced and more effective trading experience.

For further reading on using the stochastic oscillator and MACD together, see Combined Forces Power Snap Strategy.

 

5 Profitable Trading Strategies Using the MACD

Are you an indicator trader? If yes, then you will enjoy reading about one of the most widely used trading tools – the moving average convergence divergence (MACD). Today, we will cover 5 trading strategies using the indicator and how you can implement these methodologies within your own trading systems.
What is the MACD?
The moving average convergence divergence calculation is a lagging indicator, used to follow trends. It consists of two exponential moving averages and a histogram as shown in the image below:
The default values for the indicator are 12,26,9.
It is important to mention that many traders confuse the two lines in the indicator with simple moving averages.
The slower line of the moving average convergence divergence is calculated by placing a 12-period EMA on the price and then smoothing the result by another 26-period EMA. The second line is calculated by smoothing the first line by a 9-period EMA. Thus, the second line is faster and hence is the “signal” line.
The last component of the indicator is the histogram, which displays the difference between the two MAs of the indicator. Thus, the histogram gives a positive value when the fast line crosses above the slow line and negative when the fast crosses below the long.

What signals are provided by the MACD?

  1. Moving Average cross

The most important signal of the moving average convergence divergence is when the faster MA breaks the slower one. This gives us a signal that a trend might be emerging in the direction of the cross. Thus, traders often use this signal to enter new trades.

  1. Divergence

MACD also gives divergence signals. For example, if you see the price increasing and the indicator recording lower tops or bottoms, then you have a bearish divergence. Conversely, you have a bullish divergence when the price drops and the moving average convergence divergence produces higher tops or bottoms.

  1. Distance between MAs (overbought/oversold)

Since the indicator has no limit, many traders do not think of using the tool as an overbought/oversold indicator.

To identify when a stock has entered an overbought/oversold territory, look for a large distance between the fast and slow lines of the indicator.  The easiest way to identify this divergence is by looking at the height of the histograms on the chart.

This divergence often leads to sharp rallies counter to the primary trend.  These signals are visible on the chart as the cross made by the fast line will look like a teacup formation on the indicator.

5 Trading Strategies Using the MACD:

#1 – MACD + Relative Vigor Index

The basic idea behind combining these two tools is to match crossovers. In other words, if one of the indicators has a cross, we wait for a cross in the same direction by the other one. If this happens, we buy or sell the equity and hold our position until the moving average convergence divergence gives us signal to close the position. The below image illustrates this strategy:

This is the 60-minute chart of Citigroup from Dec 4-18, 2015. It shows two short and one long positions, which are opened after a crossover from the MACD and the RVI. These crossovers are highlighted with the green circles. Please note that the red circles on the MACD highlight where the position should have been closed. From these three positions, we gained a profit of $3.86 per share.

#2 – MACD + Money Flow Index

In this strategy, we will combine the crossover of the MACD with overbought/oversold signals produced by the money flow index (MFI). When the MFI gives us a signal for an overbought stock, we will wait for a bearish cross of the MACD lines. If this happens, we go short. It acts the same way in the opposite direction – oversold MFI reading and a bullish cross of the MACD lines generates a long signal.

Therefore, we stay with our position until the signal line of the MACD breaks the slower MA in the opposite direction. The below image illustrates this strategy:

This is the 10-minute chart of Bank of America from Oct 14-16, 2015. The first green circle highlights the moment when the MFI is signaling that BAC is oversold. 30 minutes later, the MACD has a bullish signal and we open our long position at the green circle highlighted on the MACD.

We hold our position until the MACD lines cross in a bearish direction as shown in the red circle on the MACD. This position brought us gains equal to $0.60 (60 cents) per share for about 6 hours of work.

#3 – MACD + TEMA

Here we will use the MACD indicator formula with the 50-period Triple Exponential Moving Average Index. We attempt to match an MACD crossover with a break of the price through the TEMA.

We will exit our positions whenever we receive contrary signals from both indicators. Although TEMA produces many signals, we use the moving average convergence divergence to filter these down to the ones with the highest probability of success. The image below gives an example of a successful MACD + TEMA signal:

This is the 10-minute chart of Twitter from Oct 30 – Nov 3, 2015. In the first green circle we have the moment when the price switches above the 50-period TEMA. The second green circle shows when the bullish TEMA signal is confirmed by the MACD. This is when we open our long position. The price goes up and in about 5 hours we get our first closing signal from the MACD. 20 minutes later, the price of Twitter breaks the 50-period TEMA in a bearish direction and we close our long position. This trade brought us a total profit of $0.75 (75 cents) per share.

#4 – MACD + TRIX indicator

This time, we are going to match crossovers of the moving average convergence divergence formula and when the TRIX indicator crosses the zero level. When we match these two signals, we will enter the market and await the stock price to start trending.

This strategy gives us two options for exiting the market, which we will now highlight:

  • Exiting the market when the MACD makes a cross in the opposite direction

This is the tighter and more secure exit strategy. We exit the market right after the MACD signal line breaks the slower MA in the opposite direction.

  • Exiting the market after the MACD makes a cross, followed by the TRIX breaking the zero line

This is the looser exit strategy. It is riskier, because in case of a change in the equity’s direction, we will be in the market until the zero line of the TRIX is broken. Since the TRIX is a lagging indicator, it might take a while until this happens.

At the end of the day, your trading style will determine which option best meets your requirements. Now look at this example, where I show the two cases