Trading forex using the MACD

The moving average convergence divergence indicator (MACD) is one of the most powerful indicators available to forex traders. As a trend-following momentum indicator, it tracks the movements of two moving averages, the 26 and the 12 MA, before subtracting these in order to combine the resulting indicator line with a 9 MA  ‘signal line’ of this. It can be displayed as either two simple lines on an indicator screen with a central ‘0’ line, or in the form of a histogram showing exactly the same information. As one of the most popular indicators, provided in every decent charting software package, the MACD is both highly reliable and offers some excellent trading opportunities for a number of profitable forex trading strategies.

Using the classic MACD to spot crossover trading setups

Similar to moving average crossover trades, the MACD provides reliable and often highly profitable trading opportunities through the crossover of the MACD and signal lines. Although these signals are not recommended to be taken on their own, additional confirmation makes these signals very reliable indicators of price swings higher or lower. The basic strategy looks for buy and sell signals as the MACD line crosses over the signal line. Waiting for the price bar to close in order to confirm that the crossover has occurred is essential to avoid false crossovers where the lines kiss but do not cross.

One popular way to filter the signals from MACD crossovers is to apply a 200 moving average to the price chart of each currency pair. As the MACD is a trend-following indicator, many traders feel more comfortable taking trades in the direction of the larger trend. Therefore, when price is below the 200 MA forex traders will only be looking for MACD crossover signals indicating short trades and when price is above the 200 MA only long trades will be taken.

MACD reversal trading strategy

One of the most powerful ways to use the MACD indicator is to spot market weakness or strength before price moves higher or lower. The divergence element of the MACD allows forex traders to identify when markets are potentially overbought or oversold according to the relationship between the moving averages. Any pair of moving averages with different values will have a tendency to move apart from one another before moving closer as price moves higher and lower. The MACD can be used to tell us when price moves higher or lower but is not supported by the underlying momentum in the market.

When the price between two currencies reaches a new high or a new low, the MACD should normally reflect this by also providing a new high or low. This can be easily seen using the histogram version of the MACD. However, occasionally, price will reach this new high or low and the MACD will reflect a lower high or low against the previous price movement. This signals to traders that there is a fundamental weakness in the price movement and that a reversal or correction is highly likely in the near future. Again, applying a confirmation indicator to determine the precise entry will result in a high probability of success from this setup.