How to incorporate MACD into your trading strategy

Date: December 7, 2005 15:00GMT 10EST

Expert: John S. Alesia, President and founder of Brown forex

Topics:
- What is the MACD?
- Moving Average Crossover
- Divergence
- Center Line Crossover
- MACD Histogram
- Combining MACD Signals

Who is John S. Alesia?
John S. Alesia founded Brown Forex after a successful career on Wall Street. Recognizing an opportunity to capitalize on an untapped retail trading market, Mr. Alesia left an executive post with Deutsche Bank to start Brown Forex. Leveraging his years of capital markets experience with hedge funds, investment banks, and institutional money managers enables Mr. Alesia to provide sage guidance and powerful resources to the retail trader.

Speech Material:

What is the MACD?
The Moving Average Convergence Divergence(MACD) is a trend follwing momentum indicator. It also does a good job of finding a reversal in trends. The MACD shows the relationship between two exponential moving averages. The most commonly used EMA's for the MACD are the 12,26,9. The MACD line is calculated by subtracting the 12 EMA from the 26 EMA with the 9 EMA used as a signal line. In addition to the moving average lines a histogram is also plotted with the MACD showing the difference between the MACD and the 9 EMA.

Moving Average Crossover
The most simple way to use the MACD is to look for a crossover of the moving averages. When the MACD line crosses to the upside of the 9 EMA that is a bullish signal, conversely when the MACD line crosses to the downside of the 9 EMA that is a sell signal.

Here is an example of both

(MACD Crossover pic)

Click to enlarge:


Here we can see the simple MACD crossover working well om a 1 hour EUR/USD chart. We get both buy and sell signals followed by decent trends to lock in profits. Using this type of signal soley will have you constantly in trades and is not very good in a whippy market. It is best if you use other indicators in combination with the MACD crossover for a better signal.

Divergence
A divergence occurs when the price moves in one direction and the MACD goes in another. This usually signals an end to a trend and a sign we will be reversing soon. This is one of my favourite indicators when looking for a slow down in a trend.

Here is an example

(MACD Divergence pic)

Click to enlarge:

 
We see that as price continued to move up the MACD was moving the opposite way. This was followed by a turn in price to the downside to follow the MACD.

Center Line Crossover
Another signal used by MACD analysts is the crossover of the center line or zero line. A bullish signal is created when the MACD moves from negative to positive and conversely a sell signal occurs when the MACD moves from positive to negative.

Here is an example

(MACD Center Crossover Pic)

Click to enlarge:

 
As you can see on this USDCHF Daily Chart, we can get many signals on these center crosses. The signal tends to be lagging and should be used as a confirmation of another signal.

MACD Histogram
The MACD histogram is the differnce between the MACD and the signal line. The histogram starts at the zero line and is pointed up when the MACD is greater than the signal line. Conversely it is pointed down when the MACD is below the signal line. We can look to the histogram for possible divergence as well as looking for peaks and troughs.

Here is an example

(MACD Histogram Pic)

Click to enlarge:

As we see on the USD/JPY Daily chart firstly and examble of divergence using the histogram. We see the histogram start to move toward the positive as the price is decreasing. This is a sign the price momentum is slowing and a possible reversal is about to occur. We also see a new low hit on the histogram chart. This is an oversold signal and a sign when the MACD crosses the signal line to the upside that momentum has come to an end and the chart has turned bullish.

Combining MACD Signals
I touched briefly on combining the signals above. Specifically in the Histogram example we see that when we hit a low on the histogram chart the following crossover confirmed we were at a low and gave us a bullish signal. This is a good example of combining indicators. I do not use the MACD crossovers exclusively. To do so would give you far too many signals and many false signals. But when used in conjuction with the divergence or the histogram we can get some stronger signals which will lead to more profits and less losses. My favorite indicator is using the MACD, looking for bullish and bearish divergence. When I see what appears to be a divergence I need to get a confirmation of that. I use the crossover of the MACD and the signal line to confirm that I am correct. Sometimes we may think we have divergence only to find the MACD continue to rise and create a new high as price is creating a new high. Like anything else patience is needed and signals must be waited for. Getting in premature does not give you a good place to exit. If I enter on a crossover I will look to exit if I get a reversal and the MACD crosses back.

Session Transcript:

FXstreet Moderator (Dec 7, 2005 10:03:01 AM)
Today I am delighted to welcome back our good friend and guest speaker John S. Alesia, President and founder of Brown forex

John (Dec 7, 2005 10:04:00 AM)
Thank you Claire

John (Dec 7, 2005 10:04:05 AM)
welcome everyone

John (Dec 7, 2005 10:04:34 AM)
today i would like to go over one of the more popular indicators and that is MACD

John (Dec 7, 2005 10:05:08 AM)
i personally am a fan of the MACD

John (Dec 7, 2005 10:05:13 AM)
and use it in my trading

John (Dec 7, 2005 10:05:35 AM)
MACD is a trend following momentum indicator

John (Dec 7, 2005 10:05:55 AM)
the most commonly used parameters are the 12,26,9

John (Dec 7, 2005 10:06:28 AM)
The MACD line is calculated by subtracting the 12EMA from the 26EMA

John (Dec 7, 2005 10:06:37 AM)
the 9EMA serves as a signal line

John (Dec 7, 2005 10:06:57 AM)
you may also have on your charts a histogram

John (Dec 7, 2005 10:07:20 AM)
this histogram is the difference between the MACD line and the signal line

John (Dec 7, 2005 10:07:55 AM)
of note on the chart is the center or zero line

John (Dec 7, 2005 10:08:05 AM)
this line shows two things

John (Dec 7, 2005 10:08:41 AM)
the macd line may cross the zero line to either side for a signal

John (Dec 7, 2005 10:09:13 AM)
and we can see the histogram go from the zero line up or down depending on which way the macd is crossing the signal line

John (Dec 7, 2005 10:09:37 AM)
hopefully you have read the speech to the left already

John (Dec 7, 2005 10:09:43 AM)
i will go over each now

John (Dec 7, 2005 10:09:49 AM)
and then answer your questions

John (Dec 7, 2005 10:10:25 AM)
firstly the most simple and most common usage of the MACD is the crossover

John (Dec 7, 2005 10:10:53 AM)
simply put when the MACD line crosses above the signal line we have a bullish signal

John (Dec 7, 2005 10:11:07 AM)
when it crosses below we get a bearish signal

John (Dec 7, 2005 10:11:15 AM)
you can see this in the chart attached

John (Dec 7, 2005 10:11:47 AM)
when the market is trending strongly

John (Dec 7, 2005 10:11:56 AM)
this works quite well

John (Dec 7, 2005 10:12:05 AM)
if we are in a ranging market

John (Dec 7, 2005 10:12:12 AM)
or one that is "whippy"

John (Dec 7, 2005 10:12:20 AM)
this will give you many false signals

John (Dec 7, 2005 10:12:25 AM)
so please be aware of that

John (Dec 7, 2005 10:12:54 AM)
lets go to the crossover of the center line

John (Dec 7, 2005 10:12:59 AM)
or the zero line

John (Dec 7, 2005 10:13:08 AM)
this too can provide a signal

John (Dec 7, 2005 10:13:37 AM)
when we go from neg to positive on the MACD this is a bullish signal

John (Dec 7, 2005 10:13:55 AM)
and conversely the cross of the zero line to the negative gives us a bearish signal

John (Dec 7, 2005 10:14:02 AM)
I do not use this often

John (Dec 7, 2005 10:14:12 AM)
most indicators are lagging

John (Dec 7, 2005 10:14:29 AM)
this signal lags behind even more so

John (Dec 7, 2005 10:14:47 AM)
it does however serve as good confirmation

John (Dec 7, 2005 10:14:58 AM)
that the trend is continuing

John (Dec 7, 2005 10:15:19 AM)
so a crossover to the upside of MACD over the signal line

John (Dec 7, 2005 10:15:28 AM)
followed by a center line crossover to the upside

John (Dec 7, 2005 10:15:37 AM)
is a good sign the market is in a cullish trend

John (Dec 7, 2005 10:16:05 AM)
my favorite usage of MACD

John (Dec 7, 2005 10:16:22 AM)
is for divergence

John (Dec 7, 2005 10:16:59 AM)
to see what i mean by divergence please look to the chart

John (Dec 7, 2005 10:17:46 AM)
this is a great example of negative divergence

John (Dec 7, 2005 10:18:11 AM)
we see price here moving to the upside

John (Dec 7, 2005 10:18:17 AM)
and setting a new high

John (Dec 7, 2005 10:18:30 AM)
yet the macd is forming a lower peak

John (Dec 7, 2005 10:18:34 AM)
and moving down

John (Dec 7, 2005 10:18:55 AM)
what i do when i see this forming

John (Dec 7, 2005 10:19:09 AM)
is look for a crossover

John (Dec 7, 2005 10:19:17 AM)
because now that signal is much stronger

John (Dec 7, 2005 10:19:24 AM)
as opposed to using every crossover you see

John (Dec 7, 2005 10:19:42 AM)
so when the MACD dips below the signal

John (Dec 7, 2005 10:19:57 AM)
a sell order should be placed

John (Dec 7, 2005 10:20:08 AM)
we can find divergence in the other direction as well

John (Dec 7, 2005 10:20:12 AM)
if we make a new low

John (Dec 7, 2005 10:20:27 AM)
and the macd does not

John (Dec 7, 2005 10:20:41 AM)
draw a similar line as to the one i have on my chart

John (Dec 7, 2005 10:20:51 AM)
look for the crossover to the upside

John (Dec 7, 2005 10:20:59 AM)
and there is where you will want to place your entry

John (Dec 7, 2005 10:21:19 AM)
this is a very strong indicator in my opinion

John (Dec 7, 2005 10:21:35 AM)
you will not find these every day

John (Dec 7, 2005 10:21:50 AM)
so be patient with them

John (Dec 7, 2005 10:22:20 AM)
the last aspect of the MACD

John (Dec 7, 2005 10:22:39 AM)
is the histogram

John (Dec 7, 2005 10:22:58 AM)
the histogram works great looking for divergence as well

John (Dec 7, 2005 10:23:11 AM)
on the chart attached you can see an example of this

John (Dec 7, 2005 10:23:27 AM)
we see price decreasing

John (Dec 7, 2005 10:23:50 AM)
as the histogram seems to have made a bottom and is now rising

John (Dec 7, 2005 10:24:12 AM)
going toward the center line and eventually positive

John (Dec 7, 2005 10:24:38 AM)
a good entry when this forms on the charts is again a crossover on the macd

John (Dec 7, 2005 10:24:54 AM)
which will flip the histogram to the positive side

John (Dec 7, 2005 10:25:32 AM)
we can also look for new lows or highs on the histogram

John (Dec 7, 2005 10:25:39 AM)
this is another reversal play

John (Dec 7, 2005 10:26:25 AM)
when the histogram makes a low or high seemingly way out of the normal range of trading

John (Dec 7, 2005 10:26:36 AM)
you can be confident we will get at least a pullback

John (Dec 7, 2005 10:26:43 AM)
if not a full reversal

John (Dec 7, 2005 10:27:20 AM)
this will basically show the market moved too far too quickly

John (Dec 7, 2005 10:27:53 AM)
my last point was on combining the macd signals

John (Dec 7, 2005 10:28:00 AM)
we really talked about that as we went

John (Dec 7, 2005 10:28:07 AM)
point i would like to get across

John (Dec 7, 2005 10:28:53 AM)
is to use the variety of signals on the MACD

John (Dec 7, 2005 10:29:08 AM)
and combine them

John (Dec 7, 2005 10:29:18 AM)
not every crossover will be a great signal

John (Dec 7, 2005 10:29:24 AM)
but when coupled with another signal

John (Dec 7, 2005 10:29:30 AM)
it certainly holds more weight

John (Dec 7, 2005 10:29:48 AM)
ok lets see what questions we have for today

John (Dec 7, 2005 10:30:18 AM)
What?s the best timeframe for entry signals using MACD?

John (Dec 7, 2005 10:30:46 AM)
When intrada trading i primarily use the 15 min

John (Dec 7, 2005 10:31:01 AM)
i love looking for divergence on the 15 min

John (Dec 7, 2005 10:31:20 AM)
if you are more of a swing trader

John (Dec 7, 2005 10:31:26 AM)
you may want to look at the 4hr

John (Dec 7, 2005 10:31:44 AM)
the macd works well on most time frames

John (Dec 7, 2005 10:32:19 AM)
what parameters for MACD you are using to trade USD/JPY and EUR/USD? moh1198

John (Dec 7, 2005 10:32:42 AM)
I stick with the 12,26,9 primarily

John (Dec 7, 2005 10:32:54 AM)
if you feel you want more signals

John (Dec 7, 2005 10:33:07 AM)
you will want to use smaller numbers here

John (Dec 7, 2005 10:33:21 AM)
but remember with more signals we get more false signals

John (Dec 7, 2005 10:33:36 AM)
work with the 12,26,9

John (Dec 7, 2005 10:33:45 AM)
play with some others after you get confident

John (Dec 7, 2005 10:35:46 AM)
d_lc78@ How does one backtest a MACD system plan?

John (Dec 7, 2005 10:36:04 AM)
well macd is no different than any other indicator when back testing

John (Dec 7, 2005 10:36:21 AM)
there are several companies out there that offer back testing systems

John (Dec 7, 2005 10:36:31 AM)
you can always do it the old fashioned way

John (Dec 7, 2005 10:36:47 AM)
and manually find your entries based on your criteria

John (Dec 7, 2005 10:37:33 AM)
for the divergence

John (Dec 7, 2005 10:37:40 AM)
you may want to go back in the charts

John (Dec 7, 2005 10:37:44 AM)
and try and see them for yourself

FXstreet Moderator (Dec 7, 2005 10:38:27 AM)
Apolgies All but I temporarily lost connection so this mean I lost all all your questions Plesase kindly post them again Thanks..

John (Dec 7, 2005 10:38:40 AM)
micholive_ng How do we recognize the divergence? How do we make the appropriet profit target after crossing the signal line?

John (Dec 7, 2005 10:38:51 AM)
Ok we went ove rthe divergence

John (Dec 7, 2005 10:39:11 AM)
so hopefully you see that better now

John (Dec 7, 2005 10:39:19 AM)
as far as a target

John (Dec 7, 2005 10:39:28 AM)
you can do a couple of things

John (Dec 7, 2005 10:39:44 AM)
if you wait for the corssover

John (Dec 7, 2005 10:39:50 AM)
to confirm the divergence

John (Dec 7, 2005 10:39:54 AM)
and the move

John (Dec 7, 2005 10:40:04 AM)
you may want to hold the trade until it crosses back

John (Dec 7, 2005 10:40:26 AM)
with that i would have a stop in

John (Dec 7, 2005 10:40:39 AM)
as to not go past my risk threshold per trade

John (Dec 7, 2005 10:40:56 AM)
incase there is a sudden shift in price

John (Dec 7, 2005 10:41:09 AM)
if market is moving at a fairly normal pace

John (Dec 7, 2005 10:41:22 AM)
you should not have that stop hit

John (Dec 7, 2005 10:41:38 AM)
you may just close when the macd crosses back

John (Dec 7, 2005 10:41:43 AM)
for a target

John (Dec 7, 2005 10:41:47 AM)
you can put in a limit

John (Dec 7, 2005 10:41:53 AM)
this may be based on your analysis

John (Dec 7, 2005 10:41:57 AM)
with a resistance line

John (Dec 7, 2005 10:41:59 AM)
fib line

John (Dec 7, 2005 10:42:02 AM)
support etc

John (Dec 7, 2005 10:42:20 AM)
or you may just let it go as far as it can until the macd is crossed

John (Dec 7, 2005 10:42:32 AM)
remember to try and stick to a good risk reward ratio

John (Dec 7, 2005 10:44:22 AM)
What about combining MACD with other inidcators, for example RSI, Stochastic?

FXstreet Moderator (Dec 7, 2005 10:44:33 AM)
Thank you John and Thank you all for reposting your questions.

John (Dec 7, 2005 10:44:34 AM)
this is a strategy used by many

John (Dec 7, 2005 10:45:22 AM)
combining indicators

John (Dec 7, 2005 10:45:51 AM)
I have certain strategies with the MACD

John (Dec 7, 2005 10:46:03 AM)
and I do not look at anything else other than support or resistance

John (Dec 7, 2005 10:46:07 AM)
when using it

John (Dec 7, 2005 10:46:14 AM)
that holds true for everything

John (Dec 7, 2005 10:46:25 AM)
knowing your support and resistance levels is very important

John (Dec 7, 2005 10:46:43 AM)
if you want to combine the MACD to get a stronger signal that is fine

John (Dec 7, 2005 10:46:55 AM)
just keep in mind the more indicators you use

John (Dec 7, 2005 10:47:00 AM)
the less signals you will get

John (Dec 7, 2005 10:47:13 AM)
that is not always a bad thing

John (Dec 7, 2005 10:47:18 AM)
but needs to be understood

John (Dec 7, 2005 10:47:31 AM)
many wait for 7 different things to happen to enter a trade

John (Dec 7, 2005 10:47:34 AM)
and never trade

John (Dec 7, 2005 10:47:41 AM)
so play with the other indicators as well

John (Dec 7, 2005 10:47:54 AM)
but try using MACD in its various ways before adding anything else

lcc (Dec 7, 2005 10:48:37 AM)
When an MACD divergence occurs, does this alway imply that px will turn around and follow th MACD trend, or could it also indicate that px may go sideways/consolidate. Does the degree of divergence matter therefore?

John (Dec 7, 2005 10:49:04 AM)
well as soon as you say always the answer is going to be no

John (Dec 7, 2005 10:49:16 AM)
nothing is absolute

John (Dec 7, 2005 10:49:28 AM)
you may indeed get consolidation

John (Dec 7, 2005 10:49:45 AM)
but i have used the divergence to find a reversal in price quite successfully

John (Dec 7, 2005 10:50:05 AM)
the worst case scenario on consolidation is you will get out at a slight gain or loss

John (Dec 7, 2005 10:50:23 AM)
but if the prie indeed reverses you can have a very profitable trade

r_firestone (Dec 7, 2005 10:50:51 AM)
When you talked about cmbining with other signals, is that just MACD signals or is that MACD + another indiator? if so what indicator?

John (Dec 7, 2005 10:51:18 AM)
for this discussion we really wanted to talk about combining the macd signals with themselves

John (Dec 7, 2005 10:51:53 AM)
other wise you will always be in a trade if you are using crossovers soley

kraft-ebbing (Dec 7, 2005 10:53:16 AM)
Is there a trend reversal sign if MACD makes new high or low but the price does not?

John (Dec 7, 2005 10:53:48 AM)
good question

John (Dec 7, 2005 10:54:56 AM)
its hard to answer without viewing a chart

John (Dec 7, 2005 10:55:05 AM)
to see exactly what is happening with price

John (Dec 7, 2005 10:55:34 AM)
generally

John (Dec 7, 2005 10:55:45 AM)
if the MACD is making a new high or low

John (Dec 7, 2005 10:55:52 AM)
that is outside the normal range

John (Dec 7, 2005 10:55:57 AM)
of where it has been

John (Dec 7, 2005 10:56:04 AM)
and price has not made it with it

John (Dec 7, 2005 10:56:21 AM)
the pair is probably oversold or overbought

John (Dec 7, 2005 10:56:37 AM)
you could look to play the corssover from that point

John (Dec 7, 2005 10:56:48 AM)
or just be leary of jumping on the trend

John (Dec 7, 2005 10:57:00 AM)
as it may be dying out

roscopeeco (Dec 7, 2005 10:58:14 AM)
you discussed divergence using both the mcad line and the histogram. is there a difference between the two. will the mcad divergence prove to be a better signal vs. a histogram divergence or vice versa?

John (Dec 7, 2005 10:58:26 AM)
there is a difference in the two

John (Dec 7, 2005 10:58:54 AM)
the macd and price may continue trending down while the histogram is moving up

John (Dec 7, 2005 10:59:11 AM)
the histogram is going to get you in quicker usually

John (Dec 7, 2005 10:59:27 AM)
when correct it will generally get you a better entry price

John (Dec 7, 2005 10:59:44 AM)
but cant say one is better than the other

John (Dec 7, 2005 11:00:17 AM)
althought the MACD divergence has a higher win% for me

John (Dec 7, 2005 11:01:47 AM)
for a good example of histogram divergence check the 15 min gbpusd from late in the US session yesterday

FXstreet Moderator (Dec 7, 2005 11:02:10 AM)
Last Question :

Nana (Dec 7, 2005 11:02:15 AM)
How tight you use the stop with this strategy

John (Dec 7, 2005 11:02:36 AM)
i think 20 pips is enough room

John (Dec 7, 2005 11:02:50 AM)
you will find that stop is rarely hit

John (Dec 7, 2005 11:03:01 AM)
if you are using the crossover back as an exit

John (Dec 7, 2005 11:03:13 AM)
when using MACD divergence that is

John (Dec 7, 2005 11:03:34 AM)
so I would trade a lot size that i am comfortable with a 20 pip loss

John (Dec 7, 2005 11:04:00 AM)
play with this

John (Dec 7, 2005 11:04:19 AM)
the 20 pips is for a shorter term trade

John (Dec 7, 2005 11:04:29 AM)
of course swing traders will want to use a wider stop

FXstreet Moderator (Dec 7, 2005 11:05:26 AM)
Thank you very much for that, John excellant session

FXstreet Moderator (Dec 7, 2005 11:05:44 AM)
We hope you liked this new Q&A look & feel and format and that, above all, you found it useful, educational, and beneficial to your trading day!!

John (Dec 7, 2005 11:06:15 AM)
Thanks Claire

FXstreet Moderator (Dec 7, 2005 11:06:21 AM)
If your question was not answered during the course of this chat, please contact John Alesia

John (Dec 7, 2005 11:06:26 AM)
and thank you all for coming today

FXstreet Moderator (Dec 7, 2005 11:06:35 AM)
Email: jalesia@brownforex.com

John (Dec 7, 2005 11:06:49 AM)
yes i am sorry i could not get to all the questions today

John (Dec 7, 2005 11:07:03 AM)
but i will email you with any answers you may need

John (Dec 7, 2005 11:07:19 AM)
i look forward to seeing you all again

John (Dec 7, 2005 11:07:37 AM)
hope you all take these tips and use them to make some pips

FXstreet Moderator (Dec 7, 2005 11:07:41 AM)
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FXstreet Moderator (Dec 7, 2005 11:08:20 AM)
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Comments

[MACD]

MACD divergences are useful, but much care should be exercised, because looking at charts and seeing a MACD divergence is hindsight bias at its worst. Learn to objectively see in real time these divergences.