The MACD is a popular trading indicator that can be used to spot market trends and momentum. There are various ways in which to use the MACD, including the MACD reversal strategy which enables traders to potentially enter into big market trends at the very start when implemented correctly. The MACD reversal strategy can be used alone, although I prefer to confirm entry with additional technical and price action analysis as I find this can help to filter some false signals.
What is the MACD?
The moving average convergence divergence is a technical analysis tool used in forex trading and created by Gerald Appel in the late 1970s. The MACD is both a trend trading and momentum indicator that shows the relationship between two moving averages (MA) of an asset’s price.
The MACD line results from subtracting the 26-period exponential moving average (EMA) from the 12-period EMA, if using the default settings. A nine-day EMA of the MACD line is called the signal line, which is then plotted on top of the MACD line, which can function as a trigger for buy or sell signals.
MACD settings
You can adjust the MACD settings to be more short term or long term, depending on your preferred trading style. I usually stick with the default settings as I find they give a good balance between filtering out some of the market noise whilst not lagging too much.
The MACD reversal trading strategy can be used on any chart timeframe that you like. I prefer the 1-hour or 4-hour charts and above. This is because they contain more price data then say the 5-minute or 15-minute charts, which I think makes the buy and sell signals more reliable.
The MACD reversal forex strategy can also be used on any currency pair. I would probably be looking at major currency pairs such as the EUR/USD or GBP/USD. They have some of the largest trading volume which means there is usually plenty of liquidity for quick execution speeds and some big trends can be formed. Spreads are also lower when compared to more exotic currency pairs which can help to save on trading costs in the long term.
How to trade the MACD reversal strategy?
We will be looking for the MACD reversal to happen at the bottom of a downtrend or top of an uptrend. This is because we are trying to enter at the start of a market reversal so we can get in a new trend at the earliest point. We can always wait for confirmation with a pull back and continuation of the new trend, keeping an eye on key support and resistance levels in the process.
We will use the RSI indicator to check for overbought and oversold market conditions. If the MACD reversal happens around the same time as the RSI crossover and we see that the momentum of a trend is slowing down, that might be a good time to start thinking about an entry. We can confirm signals by keeping an eye on candlestick patterns that show bearish or bullish price action.
Buy signal
- Downwards trend is losing momentum
- MACD (12,26,9) histogram is below 0
- MACD main line crosses the signal line upwards
- Price has bounced from support level
- RSI (14) is around oversold (30) level
- Bullish price action
In the GBP/USD 1-hour chart below, you will see that all of the above conditions have been met. There was a downtrend which has stopped around a support level that price is bouncing from. The MACD is crossing upwards below the 0 line and the RSI is around the oversold area at 30. We have bullish engulfing candlestick patterns. We could have placed the stop loss just below the support level which is around 20 pips. Not bad when you consider this uptrend lasted for over 550 pips. There was ample opportunity to take profit or trail the stop loss when the RSI and MACD crossovers happened in the opposite direction.
Sell signal
- Upwards trend is losing momentum
- MACD (12,26,9) histogram is above 0
- MACD main line crosses the signal line downwards
- Price has bounced from resistance level
- RSI (14) is around overbought (70) level
- Bearish price action
The GBP/USD 1-hour chart below shows the downtrend that happened prior to the MACD reversal buy signal that we just took a look at. This sell trade setup ticked all of the boxes, with price turning from a resistance level. The MACD crossed over above 0 to the downside and the RSI was in the overbought zone above 70. There is bearish price action including inside bar candlestick patterns. If we placed the stop loss just above the resistance level, it would have been around 20 pips. This GBP/USD down trend went or almost 700 pips which shows how good the MACD reversal strategy can be when executed correctly and given the right market conditions. There was actually ample opportunity for additional entries on the way down.
MACD reversal strategy Pros & Cons
Pros
- Many ways in which it can be implemented
- Can be used on any currency pair and timeframe
- You can combine it with other technical indicators
- Possibility to enter market trends early
- Catch some big market moves
Cons
- Requires user initiative to time entry/exit
- Will be false signals that need filtering
- Need a good money management strategy
Conclusion: does the MACD reversal strategy work?
Yes, the MACD reversal forex trading strategy can produce some good signals. However, it does require initiative on behalf of the trader. You will need to time your entry and exit using other forms of market analysis. You will also need excellent forex money management as this can be the difference between a winning and losing trading strategy.
For instance, if a trader had a stop loss of 50 pips and take profit of just 10 pips, 1 losing trade would cancel out 5 winning trades, not even including the broker costs. On the other hand, if a trade had a take profit of 50 pips and stop loss of 10 pips, they would need 5 losses to cancel out 1 winner, not considering fees. Granted each trader would have a different win rate, but this is why it is vital to time your entry and have sensible money management in place.
If you want to give the MACD reversal strategy a try, you could always test it out on a forex demo account which you can get free from most forex brokers. This is a great way to practice your trading skills and build confidence without taking any risk. If you start to see some consistent results, then you may consider making the switch over to a real trading account.
If you are a fan of the MACD indicator, you can also see my MACD breakout strategy, MACD crossover strategy and MACD divergence strategy. If you want extra confirmation on your signals, then you might consider the double MACD strategy as well.
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.
