Use the momentum method with the MACD when the market breaks out of a channel, either by going above resistance or below support. Most of the time, this is a position trade that lasts a few days or even a month. Most brokers will charge you a small fee to keep the trade open overnight, but these trades usually bring in enough pips to make it worth your while to hold the position.
Moving Average Convergence/Divergence (MACD) is a well-known indicator that works well in momentum markets. MACD (pronounced "mac-d") plots three different exponential moving averages and shows them as two lines of different colours that cross on top of the chart or in the window below it. The MACD is on one line, and the signal or trigger line is on the other.
In the window below the price chart for a currency pair, the MACD also draws a histogram, which is a kind of bar chart. On the MACD histogram, the zero point is shown by a line called the centerline, and the bars of the chart rise and fall like waves above and below that line. The difference between the MACD line and the signal line is shown by the histogram. When the two lines cross, the histogram will show zero.
If your software platform asks you to set up the MACD, the most common settings are 12 and 26 for the indicator itself and 9 for the signal line. Try different things to see what works best for you and the way you trade.
Like the RSI, the MACD can show when a currency pair has been bought or sold too much or too little. There isn't a certain number that shows this, but when the lines of the histogram get really long, it's a good sign that a change could be coming soon.
Again, the MACD can show divergence, just like the RSI. When the price goes to a new high or low but the MACD line doesn't, it could mean that the momentum is losing strength. Again, a change could be coming.
The technique
When the MACD crosses its signal line, it's a sign to buy or sell in the same direction as the MACD line. If it falls below its signal line, see if a short trade is possible. If it rises above it, go long. This signal is especially strong if the price of the currency pair breaks above resistance or below support right after the crossover. This could be a sign of a big move.
Keep in mind that the MACD is a lagging indicator, which means that its signals won't tell you the exact highs and lows. This is why it's not helpful in a range-bound market: if you only use the MACD to determine your entry points, by the time the indicator catches up to the current price, the price may have moved so far up or down within the channel that there's no longer enough of a trade left to be profitable.
When the MACD is used in a market with momentum, where the price has broken through support or resistance and is making new highs or lows, the MACD signals may start to diverge, which could mean the trend is weakening even though it might not be. In that case, you should look at the price chart and compare what it says to what the indicators show.
For example, let's say that the GBP/USD has broken out above resistance and is reaching new highs. The break happened when the MACD crossed over its trigger line. However, as the price keeps going up, the MACD doesn't reach new highs, which shows divergence and makes you wonder if the trend is getting weaker. In the meantime, the price keeps going up.
Should you run away? No. Look at the graph.
As the GBP/USD keeps going up, it will go up and down in short- and medium-term trends, going down for a while and then going back up. This is called jitters or swing lows in the market (if the currency pair was falling, they would be called swing highs). Don't worry about it; it's nothing to worry about.
Each new low swing is higher than the one before it. The market doesn't drop so much that the long-term trend changes. Instead, it just goes backwards for a while and then keeps going up. It looks like someone is dribbling a basketball up a hill, with each dribble getting higher than the last. (You do have your stop set far enough away so that the swings don't set it off and force you out of a profitable trade. If your broker has a trailing stop, it will rise as the price rises, locking in your profits.)
Wait until that pattern breaks. The bail-out point is when a swing low goes lower than the last one. Close your trade, then sit back and figure out how much money you made.
