MACD (Moving Average Convergence Divergence) was developed by Gerald Appel
at 1981, and from this day it became one of the most used technical
analysis indicators in the financial world.
The MACD based on the moving average which is a lagging indicator (walking
behind the price) but the MACD is more sensitive for the price movements.
Note: there are three types of indicators,
lagging…
The MACD indicator consists of two lines; the first line in the
traditional MACD is the MACD line, and it uses the 12 period exponential
moving average of the price (fast EMA) minus 26 period exponential moving
average of the price (slow EMA).
How to use the MACD indicator for trading?
The MACD indicator is Bullish and Bearish signals generator that used to
forecast the market movement.
It can be used in different ways, the most used methods of MACD trading
are:
1- Moving average crossing
2- Centerline crossing.
3- Divergence.
Moving average crossing:
When the MACD crosses over upward (down to up) the 9 period simple moving
average a Bullish signal occurs.
Conversely, when the MACD crosses over upward (down to up) the 9 period
simple moving average a Bearish signal occurs (Figure 4).
Note: These signals usually false signal and must
be confirmed with other indicators signals.
Centerline crossing:
When the MACD crosses over upward (down to up) the zero line (Centerline)
a Bullish signal occurs.
Conversely, when the MACD crosses over upward (down to up) the zero line a
Bearish signal occurs (Figure 5) .
Like the Moving average crossing signals these signals must be confirmed
by other MACD signals (Divergence for example) or indicators signals.
Divergence:
When the MACD divergence from the market trend, it divergence from the
trend when the MACD makes a new high while the trend failed to reach this
high in the case it’s a Bullish signal.
Conversely, the Bearish signal occurs when the MACD makes a new low while
the trend failed to reach this low.
Note: The MACD indicator can be used too as
overbought/oversold indicator when the 12 period moving average (fast EMA)
had been crossed the 26 period moving average (slow EMA) and pulls away
for far distance and a long period, that’s usually a sign of
overbought/oversold signal and the market near to reverse its direction.
MACD Divergence Precaution
Be aware that MACD divergence on a smaller time frame is not so
significant. When it is seen on a 15 minute chart it may or may not be
very important.
If seen on a 60 minute, 4 hour, or daily chart, start doing more analysis.
If you see MACD divergence on two or more of the higher time frames, then
definitely sit up and take notice and start looking for other factors to
indicate when price may react to the divergence.
This brings us to a key point when trading MACD divergence as a Forex
signal to enter a trade. On a higher time frame, MACD divergence can be a
fairly reliable indicator of a change in price direction. However, the big
question is: WHEN?
Many traders get caught out by entering a trade too soon when they see
MACD divergence. In many cases, price has still got some muscle to
continue in the current direction. The trader who has jumped in too soon
can only stare at the screen in dismay as price shoots through his stop
taking him out.
How Can This Scenario Be Avoided
Before pulling the trigger when you see MACD divergence on the higher time
frames, be sure to look for other key Forex signals to confirm that the
divergence has really kicked in.
For example, if you see a distinctive candle pattern such as a tweezer top
or a hanging man on the higher time frame it may appear price has topped
out and is now ready to move in the other direction.
If at the same time the distinctive candle pattern is at a key level of
previous support or resistance, or at a pivot level, or a Fibonacci
retracement or extension level, you have added reason to believe this
could well be a turning point and put an entry order in at this level to
get taken in.
At the same time, you will want to consult your trading calendar to make
sure you are not entering a trade near a significant Fundamental
Announcement. Even though the MACD divergence may kick in soon, the
Fundamental Announcement could cause a major spike in price and take out
your stop.
So in summary, is MACD divergence a high probability Forex signal?
Answer: By itself NO!
How can MACD divergence be used safely?
Answer: Check to see if MACD divergence is seen on one or more
higher time frame charts such as the 60 minute, 4 hour, or daily.
Then look for other Forex signals such as candle patterns, support or
resistance levels, or Fibonacci retracement extension levels.
In other words, use MACD divergence as a confirmation Forex signal that
you are going in the right direction rather than a stand-alone Forex
signal.
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