The MACD is one of the most popular and broadly used

indicators for Forex trading. The letters M.A.C.D. is

abbreviation for Moving Average Convergence

Divergence. The MACD indicator, which requires Moving

Averages as its input, falls into the group of the lagging

indicators.

The basic function of the MACD Forex indicator is to

discover new trends and to help identify the end of

current trends. There are various ways to gauge the

signals generated by MACD, and many traders use their

own unique settings and methods around this trading

indicator.

Understanding the MACD Indicator

The MACD indicator is typically placed at the bottom of

the trading chart, in a separate window, beneath the

price chart.

The Moving Average Convergence Divergence is a

relatively easy-to-use tool, however, it is crucial to

understand it fully before attempting to trade using its

signals.
Let’s take a close look at the structure of the MACD

indicator and its default settings.

MACD Structure

The MACD indicator consists of three components. There

are two lines and a histogram. Let’s now discuss each of

these separately:

 MACD Line – The MACD line is the faster line on the

indicator. Since it reacts faster it and is more

sensitive, it generally moves above and below the

second line of the indicator.

 MACD Signal Line – The MACD signal line is the

second line of the MACD indicator. It is called a

signal line, because it generates the basic MACD

signals. Since the line is slower, it gets frequently

breached by the faster MACD line.

 MACD Histogram – The MACD histogram simply

represents the difference between the MACD line

and the signal line. The bigger the gap between the

lines, the higher the bars that the MACD histogram

will display.

Below you will see an example of the MACD indicator:

This is a zoomed image of the MACD indicator. The blue

line is the MACD line. The red line is the signal line. As

you see, the MACD line is faster and it often breaks the

signal line. The gray bars are the histogram, which move

in harmony with the distance between the two lines of the

indicator.

MACD Settings

On most trading platforms, the MACD indicator typically

comes with the default parameters 26, 12, and 9. We will

interpret the meaning of these three numbers and how

they apply to the structure of the indicator.

The “12” and “26” are mutually related. These two

numbers concern the calculation of the faster MACD line.

The structure of the MACD line comes with calculating a

12-period Exponential Moving Average on the price

action and then subtracting a 26-period Exponential

Moving Average from the result. The difference between

the two EMAs gives you the value of the faster line.

The “9” comes from the calculation of the slower line

a.k.a. the signal line. This line is a product of a 9-period

Exponential Moving Average plotted on the faster MACD

line. This is why the signal line is slower than the MACD

line – because it is the smoother version of the MACD

line.

MACD Signals

Although the MACD indicator consists only of three

components (the two lines and the histogram) it can

provide a myriad of signals. We recognize six basic

signals of the MACD and now we will discuss each of

these separately.

MACD Crossovers

The MACD crossovers involve the interaction between the

two MACD lines. The MACD line is faster than the signal

line, and it will typically cross above and below the slower

signal line.
  Bullish MACD Crossover – We have a bullish MACD

crossover when the MACD line crosses the slower

signal line in the bullish direction. This action

generates a bullish signal on the chart, which

implies that the price might start an increase.

 Bearish MACD Crossover – The bearish MACD

crossover is opposite to the bullish MACD crossover.

When the MACD line crosses the signal line in the

bearish direction, we have a bearish crossover. This

hints that the price action might be entering a

bearish move.

Above you see a bullish MACD crossover. The green

circle shows the moment when the faster MACD line

crosses the signal line in the bullish direction. The price

action increases afterwards.

MACD Divergence

One of the best uses of the MACD study in Forex trading

is in identifying divergence signals. When the general

price action on the chart and the MACD direction are in

contradiction, this clues us in that the price is likely to

change directions.

 Bullish MACD Divergence – A bullish MACD

divergence occurs when the price action is moving

downwards and the MACD is showing higher

bottoms. In this case, the MACD indicator is giving

us a strong bullish signal. Very often we will see

price begin a strong upwards move after a bullish

divergence with the MACD. Below you see an

example of a Bullish MACD Divergence. After the

occurrence of the divergence we see that the price

starts an uptrend.
  Bearish MACD Divergence – The bearish MACD

divergence happens when the price action is

increasing and the MACD lines are creating lower

tops. The bearish divergence by the MACD hints that

the price might start a bearish move. In many cases,

we will see a rapid bearish move after a bearish

MACD divergence.

MACD Overbought/Oversold

Many people don’t know this about the MACD indicator,

but the MACD indicator can also provide

overbought/oversold signals as well.

 Overbought MACD – The MACD is overbought when

the MACD line gains a relatively big distance from

 the signal line. In such cases, we expect the bullish

move to exhaust after the strong increase and a

bearish move to appear.

 Oversold MACD – The oversold MACD signal is

opposite to the overbought signal. When the MACD

line gains a relatively significant bearish distance

from the signal line, then you are getting an oversold

MACD signal. In this case we expect the price to

exhaust in its decrease and to initiate a new bullish

move.

In the green rectangle on the image above you see a case

where the fast MACD line gains a relatively big distance

from the red signal line. This indicates an oversold MACD

signal. The price of the Forex pair increases afterwards.

Technical Analysis Using MACD

As you see, the MACD indicator is pretty rich on technical

signals, and is a very versatile trading tool. You can also

trade effectively by using MACD in combination with

price action analysis. Let’s have a look some trading

examples using the MACD below:

Above you see the MACD indicator applied to an MT4

chart. The indicator is attached at the bottom of the price

graph. The image starts with a bearish divergence

between the price action and the MACD indicator. As you

see, the price creates higher highs, while the tops of the

MACD indicator are decreasing (blue). The two MACD

lines cross afterwards and the price drops. Then we see

four more price swings related with bullish and bearish

MACD crossovers. Every time the two lines cross we see

a price swing in the direction of the crossover. Now let’s

shift to another example using MACD analysis:

In this case, the price decreases after a bearish MACD

crossover. However, 7 periods later we see a potential

oversold MACD signal. The MACD line gains a significant

bearish distance from the signal line. This implies that the

Forex pair may be oversold and ready for a bounce. As

you see, the price increases afterwards.

Forex MACD Trading System

Keeping in mind the six technical signals we discussed

above we can divide the trade entry rules of the MACD

indicator with the two types: bullish and bearish.

Bullish MACD Signals – Consider opening long trades

after each of these three signals.

 Bullish MACD Crossover

 Bullish MACD Divergence

 Oversold MACD

Bearish MACD Signals – Consider opening short trades

after each of these three signals.

 Bearish MACD Crossover

 Bearish MACD Divergence

 Overbought MACD

Stop Loss on MACD Trades

When you open a trade using a MACD analysis, you will

want to protect your position with a stop loss order. To

place your stop loss order effectively, you should refer to

the chart for previous price action swing points.

If you are opening a long trade, you could place your stop

loss below a previous bottom on the chart. If you trade

short, then you could place your stop loss order above a

previous top. If the price action creates a lower low on a

long trade, or higher high on a short trade, your position

will be closed automatically.

Taking Profit on MACD Trades

One way to exit a MACD trade is to hold until you receive

an opposite signal. So a contrary MACD signal would be

your signal to close out your trade. However, there are

many other ways to manage your trade based on your

personal preferences.

MACD Trading Strategy Example

Now let’s look at an example of a MACD trading method

with price action analysis:

Above you see the H4 chart of the EUR/USD Forex pair

for July, 2015. The image shows a couple of trades on the

chart that incorporates the MACD lines and histogram.

The first trading signal comes when the price action

creates an Inverted Hammer candle pattern after a

decrease. A few periods later we see that the MACD lines

create a bullish crossover. These are two matching

bullish signals, which can be a sufficient premise for a

long trade. You could buy the EUR/USD currency pair as

shown by the first green circle on the price chart. A stop

loss order should be placed below the bottom created at

the moment of the reversal, as shown on the image.

The price increases afterwards and creates an AB=CD

type pattern. This would have been an optimal exit point.

After the creation of the last high, we see a reversing

move, followed by a trend line breakout. At the same

time, the MACD lines cross in bearish direction. These

are two separate exit signals, which unfortunately come a

bit late. If you closed the trade here, the trade would still

have been slightly profitable.

One thing to note is that the trend line breakout and the

bearish MACD crossover generate matching short signals

on the chart, meaning that this could provide for a short

trade opportunity.

The price starts decreasing afterwards with the creation

of a new bearish trend. The MACD lines decrease as well.

After a 6-day decrease, the two MACD lines create a

higher bottom, while the price action is still decreasing.

This creates a bullish MACD divergence on the chart. As

such, you should exit the trade when the MACD lines

cross upwards. This happens just a couple periods later,

confirming the Bullish Divergence pattern. Notice that we

didn’t hold the trade until the bearish trend line breakout,
because there was sufficient reason from the MACD

divergence formation to close earlier.

Trading MACD Divergence in Forex

Divergence trading is one of the most popular and

effective Forex strategies. However, one downside with

Divergence is that prices can stay in a divergent

formation for quite some time without reversing, and it

can sometimes be difficult to know when to enter this

type of counter trend setup. Keeping a close eye on

emerging price action patterns can be helpful in trading

divergences.
This time we have the H1 chart of the USD/CHF a.k.a. the

Swissy. The image depicts how we might trade a MACD

divergence pattern.

The image begins with a sharp price drop. Suddenly the

decrease slows down. At the same time, the MACD not

only slows down, but it starts increasing, creating a

bullish divergence. A bullish MACD crossover appears

afterwards. You could have opened the trade based on

this signal.

If you did, you would likely have gotten stopped out on

this first entry. Shortly after, we get a Hammer Reversal

candle, which provides additional confirmation of the

bullish scenario.

The stop loss on the trade should be located below the

Hammer Reversal candle as shown on the image.

You can see that the price creates a few swings while

attempting to break in the bullish direction. However, the

stop order is well positioned below the Hammer

formation and the trade survives the pressure of the

bears.

The price starts an increase afterwards. But on the way

up we notice that the price action starts creating smaller

swings. Soon after, we discover the Rising Wedge chart

pattern on the image. Since the Rising Wedge has a

strong bearish potential, a breakdown through its lower

level could be used in combination with a bearish MACD

cross to close the trade.

In our case, the MACD lines cross downwards right at the

moment of the bearish wedge breakout. This is a strong

signal that the price might initiate a decrease. For this

reason, the trade should be closed when you receive

these confluent exit signals.

You should always be watchful of price action clues when

trading MACD divergence. This way you can attain a

better understanding of where and when to enter and exit

your MACD divergence trades.

Conclusion

 The MACD indicator is one of the most widely used

indicators for Forex trading.

 MACD is an abbreviation for Moving Average

Convergence Divergence.

 It is calculated using Moving Averages, which makes

it a lagging indicator.

 The main function of the MACD is to discover new

trends and to help find the end of present trends.

 The MACD consists of three components:

 MACD line – calculated by taking the difference

between 12 and 26 period Exponential Moving

Averages

 Signal Line- smoothes the MACD line with 9

periods

 Histogram – represents the difference between

the MACD line and the Signal Line

 There are 6 basic signals related with the MACD

trade indicator:

 Bullish Crossover – bullish signal

 Bearish Crossover – bearish signal

 Bullish Divergence – bullish signal

 Bearish Divergence – bearish signal

 Oversold MACD – bullish signal

  Overbought MACD – bearish signal

 The MACD indicator provides a myriad on signals,

which makes it useful as a good standalone tool, but

the best results come when the indicator is

combined with price action analysis.

 These are the basic rules for trading with the MACD

indicator:

 Consider long trades when you see a bullish

MACD signal.

 Consider short trades when you see a bearish

MACD signal.

 If you trade long, you should put a stop below

an earlier bottom on the chart.

 If you trade short, you should put a stop above

an earlier top on the chart.

 Hold your trades until you see an opposite

MACD signal or until your stop is hit. You

should use price action clues for managing

potential exit points.