The MACD indicator is a popular tool for using in various forex trading strategies. It can be used to spot currency pair trends and momentum, as well as possible market reversals and price divergence. This makes it a versatile technical indicator that can be used standalone or in combination with other technical indicators and price action analysis. Once you know how to use the MACD, you can create a simple MACD strategy that incorporates all of the different elements of the indicator.
What does the MACD indicator do?
The moving average convergence divergence (MACD) is a technical indicator that shows the relationship between two moving averages of an asset’s price. Its purpose is to reveal changes in a trend’s direction, strength, momentum, and duration in the underlying security’s price.
On the chart, the MACD is displayed with three accompanying numbers (coordinates). The first indicates the number of periods used for the calculation of the shorter (faster) EMA. The second reveals the number for the longer (slower) EMA, while the third is the difference between both.
How to use the MACD?
As mentioned above, there are a few different ways in which you can implement the MACD indicator within your forex trading strategies. Although this is a simple MACD strategy guide, I still want to over the different ways it can be used rather than simply focusing on the basic MACD crossover.
The MACD crossover strategy involves buying when the MACD histogram goes above 0 and selling when it falls below 0. Some traders also look to buy when the MACD bars cross the MACD signal line up and sell when MACD bars cross the MACD signal line downwards.
We will consider both these MACD crossovers whilst we will also be looking at MACD divergence. This is when the MACD is making lower highs signalling that the market might be moving downwards or when the MACD is making higher lows signalling the market is moving upwards.
When we put together these different elements of the MACD indicator and also use other forms of market analysis including support and resistance along with candlestick patterns, we can time our entry better and give our forex trading strategies that extra edge.
Buy signal
- MACD main line crosses signal line upwards
- MACD is showing divergence to the upside
- Market is moving upwards
- Bullish price action
- Price bouncing from support or breaching resistance
The GBP/USD 1-hour chart below shows that all of the simple MACD strategy conditions have been met. There was an earlier opportunity that could have been taken, but I think it would have been better to wait for the trend to start developing and enter on the pullback in this instance. The MACD crossover has happened signalling an uptrend whereas price is moving away from support and we have some bullish candlestick formations including symmetrical triangles. We could have placed the stop loss just below the support level which would have been around 30 pips which is very good when you consider this uptrend lasted over 650 pips over the course of a week.
Sell signal
- MACD main line crosses signal line downwards
- MACD is showing divergence to the downside
- Market is moving downwards
- Bearish price action
- Price bouncing from resistance or breaching support
In the GBP/USD 1-hour chart below, you can see that there was a large downtrend that could have been entered using the simple MACD strategy. The MACD crossover had occurred and there was bearish MACD divergence. We also had price bouncing away from a resistance level, breaching support and a large red bar at the start of the trend. There were a few continuation patterns on the way down which could have provided other opportunities to enter the trend. If we placed the stop loss just above the recent resistance, it would have been around 50 pips. This is relatively tight when you consider that the downtrend went on for over 1,300 pips. We could have moved the stop loss to recent swing highs on the way down to lock in profits and maximise the move as much as possible.
Simple MACD strategy Pros & Cons
Pros
- Versatile forex trading strategy
- Can be used on any currency pair and timeframe
- Can spot big trends early
- Easy to understand buy and sell signals
- MACD indicator is free to use
Cons
- Requires additional confirmation
- Needs sensible money management
- Lower timeframes can give false signals
Conclusion: how good is the simple MACD strategy?
Personally, I think the simple MACD strategy is very good when it is implemented correctly alongside good forex money management and strong trading discipline. This can be the difference between good and bad results, regardless of the forex trading system that you are using.
If you have a poor risk to reward ratio, it can be hard to recover from a few losses. If you have a good risk to reward ratio then you can still make pips even with a win rate below 50%.
For instance, if your stop loss was 50 pips but take profit just 10 pips, one bad trade would wipe out 5 winners, not including broker fees. On the other hand, if you had a stop loss of 50 pips and a take profit of 250 pips, one winning trade could cancel out 5 winners, not including costs. I think this helps to emphasise the importance of good money management.
The simple MACD strategy can be used standalone or implemented as part of another forex strategy. If you want to give it a try then you could always do so on a demo account which you can get from most forex brokers. This can be a great way to practice your trading skills and improve your knowledge of the markets without taking any unnecessary risk.
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.
