The MACD is a very popular indicator for trading forex. However, many users do not know how to correctly interpret MACD signals. Whilst the majority of trading strategies involving the MACD are based on a crossover of the zero line, it can also be used to identify divergence which can increase the reliability of the indicator.
What is the MACD?
The MACD is a technical indicator used to analyse the forex market for potential entry and exit opportunities. MACD is an acronym for Moving Average Convergence Divergence. It combines a signal line and bars which make it easy to identify the MACD signals once you know how to use it. The MACD is designed to reveal changes in the strength, direction, momentum, and duration of a trend in a currency pairs price.
How to trade with the MACD
The MACD can be used in many different ways, depending on your trading style. However, I think it works best when all of the different elements of the MACD signals are combined. For instance, I would not just take a crossover of the MACD zero line as a buy or sell signal. Instead, I would want the MACD bars to be on the correct side of the MACD signal line and divergence to confirm the entry direction.
Furthermore, I would keep an eye on price action such as candlestick patterns and support/resistance for additional confirmation. I find that this can help to filter out some of the false signals. Granted, you may also filter out some good trades, but we cannot win them all.
Truth be told, a lot of the success or failure from trading with the MACD will come down to money management. 2 forex traders using different stop loss and take profit levels, could have a completely different set of results using the same forex strategy.
- Crossover of MACD zero line
- Crossover of MACD main line and signal line
- MACD divergence
What is MACD divergence?
Trend traders watch for divergences between MACD trends and price trends as a sign of a potential upcoming reversal and end of the current trend.
When the MACD indicator forms highs or lows that that exceed the corresponding highs and lows on the price, it is called a divergence. A divergence pattern between the two MACD trend lines will almost always occur right after a sharp price move, whether higher or lower.
How to trade the MACD divergence strategy
A bullish divergence appears when the MACD forms two rising lows that correspond with two falling lows on the price. A bearish divergence forms two lower highs that correspond with two higher highs on the chart. You can mark the MACD divergence of your chart and then wait for the signal to be confirmed with additional market analysis.
Bullish signal
On the EUR/USD 1-hour chart below, you will see that there was bullish MACD divergence to the upside, the main line was above zero and the signal line. Price crossed above the 14-period moving average and there was a three white soldiers candlestick pattern. These are all strong buy signals. We could have had a relatively tight stop loss around the recent support level or just below the moving average. The trade went on to move over 150 pips before it crossed back below the moving average which could have been an exit point.
Bearish signal
In the EUR/USD 4-hour chart below, you can see bearish MACD divergence and the main line was below the signal line, both suggesting the price is falling. The price also moves below the 14-period moving average whilst there is a three black crows candlestick pattern. This is all strong emphasis for a short trade. The stop loss could have been above the moving average or the latest area of resistance. We could have exited this position for around 200 pips when the MACD main line crossed back over the signal line.
Which timeframe is best for MACD?
I think that the higher chart timeframes of the 1-hour and above tend to give more reliable signals. This is because there can be a lot of noise on anything lower. You can use the MACD divergence strategy for scalping on the 1-minute and 5-minute charts, but just be aware that you may get more false signals. You would also need to spend more time looking for signals whilst it can be hard to have a favourable risk to reward ratio considering how volatile the forex market is even at the best of times.
What settings are best for the MACD?
To be honest, I use the default settings of 12 for the fast MA, 26 for the slow SMA and 9 for the MACD SMA. If these are the default settings that the developer intended for traders to use, that is good enough for me. It also means that chances are, more forex traders are using these settings so they should be seeing similar signals which can give them more of an impact. If you do lower the settings, you might get more signals but the quality might not be any better. If you increase the settings, you may see less infrequent but perhaps stronger setups.
MACD divergence strategy Pros & Cons
Pros
- Easy to understand once you know how to
- Can be used on any currency pair or other financial instrument
- Can be used on any chart timeframe
- MACD indicator is free with most platforms, including MetaTrader
- Can be combined with other indicators and market analysis
- Enter trends at the very beginning
Cons
- Works better when signals are confirmed with other analysis
- Requires excellent money management
- Take time to learn how to trade it correctly
- MACD settings can be open to interpretation
Conclusion: is the MACD divergence strategy any good?
Yes, I think it is a very good strategy when combined with other technical indicators and price action analysis. Personally, I wouldn’t take the MACD divergence signals blindly, and would look for the other elements (crossover/zero line) of the MACD to agree at the very least.
Not to mention, I would be looking to cut losing trades short and let my winning trades run. This way, it wouldn’t take one bad trade to wipe out a consecutive run of winners. I might also lock in trades at break even point and trail the remainder of the position with a trailing stop to maximise the potential.
If you decide to give the MACD divergence strategy a try, you might want to start on a forex demo account to begin with and see how things go. Once you start having some success and build enough confidence, you may consider switching over to a real account. You can get a free demo account from most forex brokers, including IC Markets.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.
