MACD is a good indicator, specially for the new traders who have not built their discipline yet. Among the lagging indicators, I like MACD more than the others. MACD is a good indicators specially for those who suffer from entering and exiting too early.
MACD forms some special and strong trade setups. MACD Divergence and Convergence are two of the strong chart patterns that MACD forms. They are very easy to locate on the charts.
I use the MACD histogram. The MACD traditional indicator has two parts. The first part consists of two lines. One of the lines is the MACD indicator itself and the other line is the moving average of this indicator. The second part is the MACD Histogram which is calculated based on the distance of the two lines. Using the histogram makes the indicator simpler, and it still reflects the signals we need to trade. So I remove the lines and I only keep the histogram. The below picture shows the traditional MACD:
The MACD default settings is 12, 26, 9. However, to remove the noise you can set it to 24, 52, 9 to make it even slower. The below screenshots are all with this slower settings. The 24, 52, 9 makes the MACD slower and it removes most of the noise. In spite of this, none of trade setups will be missed, and our entry will not be delayed at all. This is an amazing feature that MACD has.
MACD Divergence forms when the price has been going up for a long time and has formed an uptrend. When the price still keeps on going up and forms higher highs but MACD changes its direction, goes down and forms lower highs, a pattern forms on the chart which is called MACD Divergence. Of course there are some other indicators like RSI that also form divergence and convergence patterns, but MACD divergence and convergence are sharper and stronger and more famous among the traders.
MACD Divergence and Convergence are reversal chart patterns. When they form on the charts, it is a signal that the price can reverse very soon, and, in most cases it really does. But there are some cases that the price follows the same direction even after a divergence or convergence.
The below chart shows a MACD Divergence on EUR/USD weekly chart. To have a better picture from the price highs and lows, it is recommended to have Bollinger Bands on the charts too. As you see on the below chart, the price has been going up and it has formed a higher high, but at the same time MACD histogram starts going down and forms a lower high while the price goes up to form the higher high. This is called divergence:
As you see on the above chart, when the MACD’s lower high and the price’s higher high formed, a strong candlestick signal with a strong Bollinger Bands breakout also formed by one of the candlesticks. The red arrow shows this candlestick which has formed a very strong Bearish Engulfing Pattern:
Although the candlestick pattern was so strong by itself, the MACD Divergence added a big confirmation to it.
Like all the other trade setups and signals, not all of the MACD Divergence setups work as strong as the above example. The below screenshot shows another MACD Divergence (at the left side of the below chart) that formed before the one you saw above. As you see, the MACD Divergence that formed at the left, did not make the price go down as strong as the MACD Divergence that formed at the right:
You can have your stop loss always there and move it to breakeven when the price moves accordingly, so that if the price turns around suddenly you will not get out with loss:
MACD Convergence forms on the downtrends while the price keeps on going down and forms “lower lows”, but at the same time MACD histogram goes up and forms “higher lows”. Like the previous pattern, MACD Convergence is also a reversal pattern. Please note where the entry and stop loss levels are:
If you check the EUR/USD daily time frame, you can locate several MACD Divergence and Convergence patterns that most of them worked very strongly. Some traders only trade the MACD Divergence and Convergence and they do not care about the other trade setups because they believe that MACD Divergence and Convergence are the strongest trade setups.
Please note that MACD Divergence and Convergence are very strong and reliable when formed on the longer time frames like daily and weekly. The shorter the time frame, the unreliable the MACD Divergence and Convergence patterns.
In addition to MACD Divergence and Convergence, there are some more ways to use this indicator. You can have MACD on the chart as a confirmation in trading strategy that you use. For example, if you use the candlestick patterns to trade, but you want to have more confirmation to filter out more false signals and take less risk, you can use MACD.
The same strong Bearish Engulfing Pattern I described above, could be confirmed by the MACD bars too (without paying any attention to the MACD Divergence). The Bearish Engulfing Pattern formed while we already had a divergence there. However, it could form without a divergence. Divergence and convergence are the patterns that don’t form on the charts very frequently, but candlestick patterns are more frequent. Still you can use MACD to confirm the candlestick patterns you locate while there is no divergence or convergence. MACD keeps you from making mistakes and taking the weak patterns and signals. First, I show you how MACD confirmed the EUR/USD strong Bearish Engulfing Pattern I already showed you above. Then I show you some examples that MACD could prevent us from taking the false and weak patterns.
The below screenshot shows how MACD confirmed the Bearish Engulfing Pattern. As you see when the engulfing candlestick closed and the next candlestick opened, the MACD related bar and also the previous bar were getting smaller which means the market was getting bearish and the price was ready to go down, so that it was OK to take the bearish signal:
The below chart shows you too many weak candlestick patterns that you might take if you did not have the MACD on the chart. But with having the MACD, you could easily skip those weak and false setups.
1. Candlestick #1 shows a Bullish Engulfing Pattern (or a piercing line) that also has broken out of Bollinger Lower Band. However, it is not a strong signal and it had to be skipped as a reversal pattern. Novice traders usually jump in as soon as such a pattern forms on the charts. But experienced traders understand that such setups are weak and unreliable. However, when new traders have MACD on their charts (with 24, 52, 9 settings which is slower), they can easily consult the indicator and know whether the candlestick pattern is strong enough or not.
As you see, a Bullish Engulfing Pattern was formed, but MACD bars (bar #2 and the previous few bars) were going down which meant that the market was still bearish and it was not good to go long.
2. Candlestick #3 and MACD bar #4 are also like #1 and #2 that had to be skipped.
3. Candlestick #5 and MACD bar #6 are also like #1, #2, #3 and #4 that had to be skipped.
4. Candlestick #7 formed a Bearish Engulfing Pattern that somehow could be known as Dark Cloud Cover too. However, as you see, the MACD bar #8 and several previous bars have been going up strongly which means the market was still bullish and it was wrong to go short.
5. Candlestick #9 has formed a continuation signal above Bollinger Middle Band. At the same time, MACD bar #10 and the bars before and after, were going up. It means the market was bullish and it was OK to go long. This was the only good bullish candlestick pattern that was confirmed by MACD.
6. Candlesticks #11 formed a strong Bollinger Upper Band breakout that looked like a good reversal signal, but MACD bar #12 and the bars after that, were going up which means the market was strongly bullish and it was wrong to go short.
7. Candlesticks #13 and MACD bar #14 also have the same situation as the candlesticks #11 and bar #12.
Do you see how MACD can prevent us from entering the market while the reversal signal is not strong enough and the trend is still strong?
That is why I explained at the beginning of this article that MACD is a great indicator for the new traders, because they really don’t know what the best time is to get in the markets. They jump in as soon as they see a pattern that can be false or too weak.
I can show you hundreds of examples like this, both from the patterns and signals that MACD confirmed and they really worked, and from the weak patterns and signals that MACD did not confirm, and so the related patterns and signals had not been followed by the price reversal.
MACD helps you build your disciple, because you see some signals on the charts, but you don’t enter because MACD says “no”, whereas when MACD is not on the chart, you enter and you lose.
This is how you can use MACD. Add this indicator to a chart, set it to 24, 52, 9, and try to locate the trade setups like the ones I showed you above. See how MACD confirms some trade setups and rejected the others. Then answer the below questions and decide:
- Can MACD help you make more money?
- Can MACD help you lose less money?
- Can MACD help you have lower risk and higher reward?
- If you have been losing so far, do you think that MACD can help you become profitable from now on?