The MACD is one of the most versatile indicators, which allows us so many things to achieve while trading.
- Intraday trading;
- Divergence Trading;
- MTF trading;
- MACD patterns.
In the article, you will learn the optimal MACD settings for intraday and swing trading.
What is the MACD Indicator?
The MACD abbreviation stands for Moving Average Convergence Divergence. The MACD indicator calculation or formula is derived by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the signal line, is then placed on top of the MACD, which marks triggers for potential buy and sell signals.
Author and financial analyst Gerald Appel created the MACD indicator in the late 1970s. We can use the MACD in multiple ways as it is one of the most popular trading indicators.
MACD Formula
The MACD calculation of 26,12,9 is the default setting. The MACD is a lagging indicator, as the trend it captures is lagging. This is a very good thing for traders as it allows for multiple uses, including MTF trading.
How to Read the MACD Divergence
The bullish divergence happens when the price is making a lower low, but the MACD is making a higher low If the MACD is making a lower high, but the price is making a higher high – we call it bearish divergence.
Take a look at these examples of multiple divergence points for a better understanding of MACD.
Let’s see an example of a bullish divergence with a trend line breakout.
Now, time for an example of a bearish divergence with a trend line breakout.
How to Trade Using MACD
By using the above-mentioned divergence of MACD signals, we can find a simple MACD trading system and make a non-clustered MACD chart.
The rules are as follows:
Long Trades:
- The price makes a bearish divergence
- We draw a trendline
- We wait for a trendline to break and go with a candlestick signal trade.
Short Trades:
- The price makes a bearish divergence
- We draw a trendline
- We wait for a trendline to break and go with a candlestick signal trade.
With entries like these, you will ensure that you follow the divergence, the MACD charts’ flow, and using the MACD signals correctly. Don’t forget that MACD stands for Moving Average Convergence Divergence. The word divergence describes what we are trying to achieve with this strategy.
In most cases, I use candlestick patterns to confirm my entry point. For instance, with the long setups, I like to wait for a clear entry; with the breakout setup, which you will use for a trendline break in most cases, you need to wait either for a breakout trigger happy entry or breakout-retest or eventually breakout-retest-continuation pattern.
Sometimes I exaggerate in finding a precise and ‘fancy’ entry, so at times I also set up pending orders. However, my confidence level in the setup has to be higher.
How to Read the MTF with the MACD
The higher time frames are the best for viewing trends, momentum, and divergence in general. We need to align all the timeframes and find the best possible entry. For that one, we need a double MACD indicator, which is a standard variation of the MACD.
Higher Time Frames
The MTF trading stands for Multiple Time Frame trading. We drill down from higher time frames to lower time frames aligning both trend, momentum and entry. We use Monthly, Weekly and Daily.
The thick blue histogram marks the uptrend while the thick red marks the downtrend.
Lower Time Frames
The histogram is thick blue, and the blue MACD line is ABOVE the 0 line for uptrends. For downtrends, the histogram is thick red, and the blue MACD line is BELOW the 0 line.
We use Monthly, Weekly and Daily.
Uptrend
Downtrend
Momentum
When we determined the trend, the next thing we do is identifying momentum. To do that, we need to have an opposite move to a trend.
To find an entry, we must first wait for a retracement or a pullback. The thinning histogram indicates a retracement on the MACD indicator.
Let’s say that we have an uptrend on a D1 time frame which is indicated by a thick blue histogram. We drill down to H4, which should have a thinning histogram. That suggests a pullback on a 4h timeframe.
By aligning a daily trend with a 4h momentum, we can then move on to lower time frames and search for an entry.
How to Trade the MACD
With the above example, we are ready to search for entries. We need to drill down to the H1 timeframe. By having the uptrend on daily, a retracement in the 4h timeframe, we need to find a long entry on the h1 timeframe.
The entry could be a candlestick pattern, a chart pattern, a harmonic pattern, or whatever means a trader uses for an entry. If we trade the MACD, we can use both signals from different indicators combined with the MACD or the price action itself.
Having aligned both trend, momentum, a retracement or a divergence, we are ready to trade the MACD.
Head and Shoulder Patterns in the MACD
The MACD can also show patterns as a candlestick chart does. If you are familiar with price formations, then you may already know the bullish Inverse Head and Shoulder pattern or the bearish Head and Shoulder pattern.
You can apply Head and Shoulder patterns to different systems and strategies, but instead of 12,26,9.
Inverted Head and Shoulder MACD Pattern
The Inverted Head and Shoulder pattern marks a possible retracement or a reversal from a downtrend to an uptrend. After you spot the pattern, try searching for a long entry using either candlestick or chart patterns or any different method for a long entry. My suggestion is to use the candlestick entry.
Head and Shoulder MACD Pattern
The Head and Shoulder pattern marks a possible retracement or a reversal from an uptrend to a downtrend. After you spot the pattern, try searching for a short entry using either candlestick or chart patterns or any different entry method. My suggestion is to use the candlestick entry.
Pros and Cons of Using the MACD
The MACD is a lagging indicator. That means that you need confirmation from a leading indicator or the price action itself. Failing to do so could lead to a late entry, and the risk to reward will become less than optimal.
A merit of using the MACD is that it captures the trend perfectly due to being a lagging indicator, and it allows you to ride that trend for a more extended period. That is particularly a good thing because by pairing it with a proven leading indicator or a candlestick pattern, you will be able to spot entries in a more precise and distinct way.
In addition to MACD there are other indicators that I offer here, and also check my trading results at myfxbook.com and start a membership at discord, telegram group by getting a whooping 50 % discount for a new XM account
Cheers and safe trading,
Nenad
