One way to simplify trading is through a trading plan that includes a reliable indicator such as the MACD. This article will look at the MACD (moving average convergence/divergence) trading strategy and how it can be used to identify both the direction and momentum of the trend.
MACD Trading Strategy to Find and Enter a Trend
Finding the trend is arguably one of the most important steps every technical trader must tackle in their trading and while this may appear to be a difficult task, the MACD can be extremely useful in this regard.
Three steps to find and enter a trend using MACD:
- Identify direction of the trend
- Use MACD crossover for opportunities in the direction of the trend
- Use MACD zero line to manage risk
1. Identify direction of the trend
One way for traders to identify a trend is by using the 200-day moving average. If a trader is looking to buy into a position, they can apply the 200-day moving average to the price chart to determine whether prices are consistently trading above the average range.
In the example below, the EUR/USD chart shows a prevailing upward trend which is confirmed by prices consistently trading above the 200-day moving average. When this happens, the buyer can move onto the second step to determine possible entry points.
2. Use MACD crossover for opportunities in the direction of the trend
Once the trading bias has been established, traders will begin looking for buy signals in the same direction as the current trend.
In the chart above, when the price is ABOVE the 200-day moving day average, the MACD crossover can be used for a potential entry signal.
As outlined on the chart, a trader could look to enter a long position at the first highlighted MACD crossover. At this point the MACD line (the blue line) is above the signal line (the red line) and the price is still trading above the 200-day MA.
3. Use MACD zero line to manage risk
When trading trends, it is important to know that they will eventually come to an end. In an uptrend like the EUR/USD, when there is a bearish crossover, this can be a sign that the momentum of the uptrend is slowing down and that it could possibly be changing direction.
A trader with a long position could look to exit the position at this point, however it could just be a temporary pullback. When the bearish crossover occurs, traders could look for the signal line to cross below the zero line, confirming the downward trend. At this point they can exit the trade.
MACD Strategy to Identify Tired Trends
A trend following strategy is popular amongst both new and experienced traders. Majority of traders have entered a trade at the end of a trend only to see the trend reverse. Can the MACD trading strategy help traders locate a tired trend?
A good way to identify changing trends is with MACD divergence. Divergence normally occurs when the indicator is moving in a different direction from price which suggests that the momentum of that is trend is slowing down.
Below we can see the Germany 30 forming a higher high on the price chart, while MACD is making a lower high, this is divergence. This is our first indication that price momentum from the current trend is slowing. At this point, traders should consider reducing and possibly closing out any existing long positions.
Once divergence has been identified, traders can then look for execution using a classic MACD crossover. Traders who have entered into long positions can exit the trade at the next bearish crossover (where the blue MACD line crosses below the red signal line in a downtrend), protecting the trader from losses that could occur if there is a reversal.
Although the MACD trading strategy is often used to identify possible entry triggers, it is also effective for determining exit triggers as seen with divergence. Although timing of an entry is extremely important, risk management should never be ignored.
MACD Trading Strategy FAQ:
Is there a faster method to enter trades using the MACD indicator?
While the MACD crossover is the most popular method for determining entry signals, the MACD histogram can be used as an alternate method and is often used by less conservative traders.
What other tools are useful when entering trades with MACD?
Although an indicator, such as the MACD is a good tool to use, IG client sentiment could be used as an additional tool to assess how other traders are reacting to markets. By combining these methods, the trader is able to get a holistic view on the market and can then use the MACD to determine possible entry and exit points.
Improve Your Trading Skills
- Interested in learning more about MACD? Find out how to adjust MACD settings to make the most of your trades
- Struggling to find an indicator that suits your strategy? Take a look at 4 effective trading indicators every trader should know.
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