Incorporating the MACD Into Your Forex Day Trading

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Incorporating the MACD Into Your Forex Day Trading

When a strategy provides a lot of signals, such as the one I use for trading a 1-minute or 5-minute chart on the EURUSD (see: Forex Day Trades – October 7 and subsequent posts), some traders may find it beneficial to add an indicator to help them figure out which signals to take and in which direction.

The MACD can help in this regard. The reason I don’t personally use indicators is that there is a tendency to become too reliant on them, and thus get sloppy and lazy in reading the price action. Pay attention to the velocity, direction and magnitude of price moves to get the most insight to what the price is likely to do next. When learning though, a MACD can help you establish when you should be going long, or going short.

Figure 1 shows part of the London session, with the pullbacks marked with arrows as potential entry points in the current trend.

Starting from the left, the MACD stays below the zero line. This indicates the trend is down and you’re only looking for short trades. The down arrows mark all the potential short entries if you were simply to take the shorts at the upper envelope band. I usually wait to see how the price reacts around the band before entering, so my entries don’t always occur right at the band.

Two of the down arrows also have an “x” above them. These are trades I would have missed because I was already short from a prior signal. Not all these trades would have been winners, even though the price continued to trend down.

Figure 1. Entries with MACD Confirmation

The last downside trade may be a small profit for some traders or a small loss for others depending on how the trade was managed after the price failed to make a new low.

The MACD then moves above the zero line, indicating the short-term trend is to the upside and you’re looking for long/buy trades. Three long trades are marked.

The first two trades are profitable, while the profitability of the third will depend on how the trade is managed. After the third long entry the price makes several small attempt to make a new high, but can’t. This indicates a bigger pullback is likely coming so a small profit should be taken. See How to Read the EUR/USD-October 16 Day Trades for guidance on how to actively manage trades.

In figure 1 the both the uptrend and downtrend managed to sustain themselves for at least a few waves, allowing for at least a couple profitable trades.

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The MACD will always be either positive or negative, but that doesn’t mean all trades should be taken. If the MACD is moving back and forth across the zero line rather rapidly, then there likely isn’t a sustainable trend worth trading. In the chart above the MACD stays below, and then above, the zero line for some time, which is a sign of a good tradable trend.

If the price isn’t moving in one direction for more than a couple waves at a time, it is probably best not to trade since the price action is too choppy. If you look at a chart and the trend doesn’t look similar to the down or (smaller) uptrend in Figure 1, then trend trading may not ideal in those conditions.

The MACD can help you with deciding which side of the market to trade on–long or short. But you still need to monitor the price action and determine if the trend is strong or weak so you can decide which trades to take.

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This article will provide an explanation of what the MACD indicator is, and it will explore the various features of the MACD indicator, how to scalp with the MACD indicator, how to perform intraday trading with the MACD indicator, MACD breakouts, MACD patterns, and much more!

The MACD is an indicator that allows for a huge versatility in trading. We can use the MACD for:

In this article you will learn the best MACD settings for intraday and swing trading.

What is the MACD Indicator?

MACD stands for Moving Average Convergence Divergence. It is a trend-following, trend-capturing momentum indicator, that shows the relationship between two moving averages (MAs) of prices. The MACD was created by Gerald Appeal in the late 1970s. The MACD indicator formula is calculated by subtracting the 26-day Exponential Moving Average (EMA) from the 12-day EMA.

A nine-day EMA of the MACD is known as the signal line, which is plotted on top of the MACD, usually marking triggers for buy and sell signals. This is a default setting. The MACD is a lagging indicator, also being one of the best trend-following indicators that has withstood the test of time. You don’t need to download the MACD indicator separately, as it is already built into the MetaTrader 4 (MT4) platform.

Depicted: USD/CAD Hourly Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Another version of the MACD is the so-called ‘2-line MACD’, which can also be combined with great trading strategies. The difference is that the default MT4 MACD indicator lacks the fast signal line (instead of showing the fast signal line, it gives you a histogram of it).

For trading, it’s completely irrelevant, as long as you use it with other tools that work in conjunction with the MACD itself. When the red and blue MAs cross on the 2-line MACD, it is equivalent to the red MA line crossing the green histogram on the default MT4 MACD. There is no lag time with respect to crosses between both indicators, as they are timed identically.

Depicted: GBPJPY Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

MACD Divergence

Understanding MACD convergence divergence is very important. When the price is making a lower low, but the MACD is making a higher low – we call it bullish divergence. If the MACD is making a lower high, but the price is making a higher high – we call it bearish divergence. Divergence will almost always occur right after a sharp price movement higher or lower. Divergence is just a cue that the price might reverse, and it’s usually confirmed by a trendline break. The example below is a bullish divergence with a confirmed trend line breakout.

Depicted: An Example of a Confirmed Break – EUR/USD Hourly Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Depicted: Example of a Bearish Divergence With a Trendine Breakout – EUR/USD Hourly Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Intraday Trading with the MACD Indicator

The MACD can be used for intraday trading with default settings (12,26,9). If we change the settings to 24,52,9, we might construct an interesting intraday trading system that works well on M30. The intraday trading system uses the following indicators:

The system is traded on 30-minute time frames, and it is suitable for trading major Forex currency pairs such as: EUR/USD, GBP/USD, USD/JPY, USD/CHF, AUD/USD, and other currency pairs like: GBP/JPY, AUD/JPY, USD/JPY, NZD/JPY, and GBP/NZD.

Depicted: EUR/USD M30 Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

The rules are as follows:

  • The price should be above the SMMA
  • The MACD should be below the 0 line
  • The William % Range should be crossing -80 from below
  • The price should be below the SMMA
  • The MACD should be above the 0 line
  • The William % Range should be crossing -20 from above.

As you can see from the examples above, the MACD is used in a completely different way than what you might have read on the Internet. The reason being – the MACD is a great momentum indicator and can identify retracement in a superb way. Don’t forget the basic principle of trading – in an uptrend, we buy when the price has dropped; in a downtrend, we sell when the price has rallied. This is exactly what the MACD is pinpointing at – when the price is ready to be sold and/or bought. Trading with the MACD should be a lot easier this way.

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Scalping With the MACD Indicator

This scalping system uses the MACD on different settings. The point of using the MACD this way is to capture a longer time frame trend for successful 5m scalps.

  • EMA 34 (Blue)
  • EMA 55 (EMA)
  • MACD (34,89,34)
  • Stochastic Oscillator (8,1,3 and 13,1,3), overlaid
  • Admiral Pivot set on H1 (requires MT4SE)

Pairs: EUR/USD (focus), GBP/USD, GBP/JPY, USD/JPY, AUD/USD, EUR/JPY, USD/CHF

  • The Blue 34 EMA should be above the Red 55 EMA
  • The MACD should be above the 0 line
  • The Stochastic (at least one of them) should be recently oversold at the 20 level, and should be crossed up
  • The Target is an Admiral Hourly PP
  • The Blue 34 EMA should be below the Red 55 EMA
  • The MACD should be below the 0 line
  • The Stochastic (at least one of them) should be recently oversold at the 20 level, and should be crossed up
  • The Target is an Admiral Hourly PP
  • Stops go below the Admiral Pivot support (for longs) or above the Admiral Pivot resistance (for shorts).

Depicted: An Example for Short Entries – EUR/USD M5 Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Depicted: An Example for Long Entries – GBP/JPY M5 Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

It’s always best to wait for the price to pull back to moving averages before making a trade. Bear in mind that the Admiral Pivot will change each hour when set to H1. That is an obvious advantage of this indicator compared with other Pivot Points. H1 Pivot is best used for M5 scalping systems.

MACD Breakouts

The MACD breakout is used to confirm Admiral Pivot breakouts in the trend direction. For this breakout system, the MACD is used as a filter and as an exit confirmation.

  • Admiral Pivot (D1) (requires MT4SE)
  • 50 exponential moving average (50 EMA)
  • 200 exponential moving average (200 EMA)
  • MACD indicator (12, 26, 9)

Currency pairs : EUR/USD, GBP/USD, AUD/JPY, GBP/JPY, USD/CHF, NZD/USD, AUD/USD

Take breakout trades only in the trend direction. The trend is identified by 2 EMAs. The trend is up if the 50 EMA is higher than the 200 EMA. The trend is down if the 50 EMA is lower than the 200 EMA.

  • The trend is up (50EMA >200EMA), the MACD histogram is above the 0 line, and the candle closes above the Pivot Point.

    The trend is down (50EMA AUD/JPY Hourly Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Depicted: GBP/USD Hourly Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Effective Combo with Admiral Keltner Indicator

This strategy uses the following indicators applied on the chart:

  • Bollinger Bands®: Length 20, Standard Deviation 2
  • Admiral Markets Keltner (MT4SE with default settings)
  • MACD (12,26,9)
  • Admiral Pivot (has variable settings, which is explained below)

With both Bollinger Bands®, Admiral Keltner, and the MACD indicators, you should use the default settings that are used on the vast majority of trading platforms. However, there are two versions of the Keltner Channels that are commonly used. Admiral Keltner is possibly the best version of the indicator in the open market, as the bands are derived from the Average True Range (ATR).

Consider only taking a Bollinger Bands® with Admiral Keltner breakout strategy trade when both the upper, and lower Bollinger Bands® go inside the Keltner Channel, with the MACD confirmation. The yellow highlights (in the graph below) shows examples of Bollinger Bands ® (green lines) going inside the Keltner Channel (red lines). At those zones, the squeeze has started. However, we still need to wait for the MACD confirmation.

Depicted: GBP/JPY M30 Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

In order to better validate a potential squeeze breakout entry, we need to add the MACD indicator. After plotting Bollinger Bands and MACD on our charts (both with default settings), we must wait for a contraction on the bands and MACD confirmation. When Bollinger Bands® (both green lines) start to come out of the Keltner Channel (red lines), the squeeze has been released, and a move is about to take place. Wait for a candle that breaks above or below the bands, as a buy or sell trade trigger confirmed by the MACD.

Bollinger Bands® and Keltner Channels inform you when the market is transitioning from lower volatility to higher volatility. Using these two indicators together is stronger than only using a single indicator, whereas both indicators should be used together. In this trading method, the MACD is used as a momentum indicator, filtering false breakouts. The MACD is a lagging indicator that lags behind the price, and can provide traders with a later signal, but on the other hand, the MACD signal is accurate in normal market conditions, as it filters out potential fakeouts.

Trade Trigger

Depicted: EUR/USD Hourly Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

  • When a squeeze is formed, wait for the upper Bollinger Band to cross upward through the upper Keltner Channel, and then wait for the price to break the upper band for a entry long.
  • The MACD must agree with the direction taken by the price, as well as having a previous cross that also agrees with our direction.
  • When a squeeze is formed, wait for the lower Bollinger Band to cross through the downward lower Keltner Channel, and wait for the price to break the lower band for a entry short.
  • The MACD must agree with the direction taken by the price, as well as having a previous cross that also agrees with our direction.

Another example is shown below. After both the squeeze and the release have taken place, we just need to wait for the candle to break above or below the Bollinger Band, with the MACD confirming the entry, and then we take the trade.

Depicted: AUD/USD Hourly Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Recommended time frames for the strategy are M30-D1 charts. The strategy can be applied to any instrument. Intraday breakout trading is mostly performed on M30 and H1 charts. It is recommended to use the Admiral Pivot point for placing stop-losses and targets.

A stop-loss for buy trades is placed 5-10 pips below the Bollinger Band middle line, or below the closest Admiral Pivot support, while a stop-loss for short trades is placed 5-10 pips above the Bollinger Band middle line, or above the closest Admiral Pivot support. Target levels are calculated with the Admiral Pivot indicator. For a M30-H1 chart, we use daily pivots, for H4 and D1 charts, and Weekly pivots. Both settings can be changed easily in the indicator itself.

Depicted: GBP/AUD Hourly Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

MACD Patterns

When we apply 5,13,1 instead of the standard 12,26,9 settings, we can achieve a visual representation of the MACD patterns. These patterns could be applied to various trading strategies and systems, as an additional filter for taking trade entries. It is argued that, the best MACD setting for a MACD pattern is 5,13,1.

MACD Bullish SHS

This is a Bullish SHS (Inverted Head and Shoulders pattern) that marks a reversal, and a possible turn to an uptrend. A possible entry is made after the pattern has been completed, at the open of the next bar.

MACD Bearish SHS

This is a Bearish SHS pattern (Head and Shoulders) that marks a reversal and a possible turn to an uptrend. A possible entry is made after the pattern has been completed, at the open of the next bar.

MACD Bullish Continuation

A bullish continuation pattern marks an upside trend continuation. First, the MACD makes a downside turn from point A, marking a retracement. Subsequently, when point A is broken by the MACD histogram, it is a signal for a long entry.

MACD Bearish Continuation

A bearish continuation pattern marks an upside trend continuation. First, the MACD makes an upside turn from point A, marking a retracement. Subsequently, when point A is broken by the MACD histogram, it is a signal for a short entry.

MACD Bullish 0 Line Rejection

When the MACD comes down towards the Zero line, and turns back up just above the Zero line, it is normally a trend continuation move. Points A and B mark the uptrend continuation.

MACD Bearish 0 Line Rejection

When the MACD comes up towards the Zero line, and turns back down just below the Zero line, it is normally a trend continuation move. Points A and B mark the downtrend continuation.

Depicted: Examples As Seen On The Charts – GBP/JPY Hourly Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Depicted: GBP/JPY Hourly Chart – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Bear in mind that the best time frame for the MACD patterns is H4. By using MACD the right way, you should hopefully empower your trading knowledge and bring your trading to the next level! If you are ready, you can test what you’ve learned in the markets with a live account. If you need some practice first, you can do so with a demo trading account. Demo trading accounts enable traders to trade in a risk-free trading environment, whereby traders use virtual funds, so that their capital is not at risk.

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

Trading the MACD divergence

Moving average convergence divergence (MACD), invented in 1979 by Gerald Appel, is one of the most popular technical indicators in trading. The MACD is appreciated by traders the world over for its simplicity and flexibility, as 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.

Key Takeaways

  • Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price.
  • Traders use the MACD to identify when bullish or bearish momentum is high in order to identify entry and exit points for trades.
  • MACD is used by technical traders in stocks, bonds, commodities, and FX markets.
  • Here we give an overview of how to use the MACD indicator.

MACD: An Overview

The concept behind the MACD is fairly straightforward. Essentially, it calculates the difference between an instrument’s 26-day and 12-day exponential moving averages (EMA). Of the two moving averages that make up the MACD, the 12-day EMA is obviously the faster one, while the 26-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.

Figure 1 is a good example of a MACD histogram in action:

Figure 1: MACD histogram. 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. 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:

Figure 2: 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 0.3307. (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.

Source: Source: FXTrek Intellicharts

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:

Figure 3: 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.

Source: Source: FXTrek Intellicharts

One of the reasons traders often lose with this setup is that 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 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 100,000 units or as little as 1,000 units for the same typical spread of 3-5 points in the major pairs.)

In effect, this strategy requires the trader to average up as prices temporarily move against him or her. This is typically not considered a good strategy. Many trading books have derisively dubbed such a technique as “adding to your losers.” However, in this case, the trader has a logical reason for doing so: The MACD histogram has shown divergence, which indicates that momentum is waning and price may soon turn. 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:

Figure 4: 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.

Source: Source: FXTrek Intellicharts

The Bottom Line

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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