The MACD Trading Strategy, Explained

July 06, 2021 19:56 UTC
Reading time: 31 minutes

This article explains what the MACD indicator is and explores the various features of the MACD indicator, how to scalp with the MACD indicator, strategies that pair the MACD indicator with other indicators, the best indicator settings for a MACD trading strategy, MACD breakouts, MACD patterns, and much more!

Perhaps you've been asking yourself, "Is the MACD a good indicator?" Before I answer these questions, let’s give an overview of what the MACD indicator is.

The MACD is an indicator that allows for a huge versatility in trading. We can use the MACD for:

  • Divergence
  • Intraday trading
  • Crossover trading
  • Scalping
  • Breakouts
  • MACD patterns

In this article, you will learn the best MACD settings for day trading (for a MACD day trading strategy) and swing trading.

What is the MACD Indicator?

Let's begin. In this article, you'll find everything you need to know about the MACD indicator and using a Forex MACD trading strategy (MACD strategy for Forex trading). So, you don't need to go searching online for a MACD trading strategy on Reddit, where the reliability of your results can be questionable.

MACD stands for Moving Average Convergence Divergence. It is a trend-following, trend-capturing momentum indicator, that shows the relationship between two moving averages (MAs) of prices. The MACD was created by Gerald Appel in the late 1970s. The MACD indicator formula is calculated by subtracting the 26-day Exponential Moving Average (EMA) from the 12-day EMA.

A nine-day EMA of the MACD is known as the signal line, which is plotted on top of the MACD, usually marking triggers for buy and sell signals. This is a default setting. The MACD is a lagging indicator, also being one of the best trend-following indicators that has withstood the test of time. This is why it is so desirable to know the best MACD indicator settings for day trading to implement a simple MACD trading strategy.

You don't need to download the MACD indicator separately, as it is already built into the MetaTrader 4 (MT4) trading platform. With the best MACD indicator settings for day trading, you can bring about great changes to your different day trading strategies.

Depicted: USD/CAD Hourly Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Another version of the MACD is the so-called '2-line MACD', which can also be combined with great trading strategies, which is then sometimes referred to as the 2 MACD trading strategy. The difference is that the default MT4 MACD indicator lacks the fast signal line (instead of showing the fast signal line, it gives you a histogram of it).

For trading, it's completely irrelevant, as long as you use it with other tools that work in conjunction with the MACD itself. When the red and blue MAs cross on the 2-line MACD, it is equivalent to the red MA line crossing the green histogram on the default MT4 MACD. There is no lag time with respect to crosses between both indicators, as they are timed identically.

Along with the best MACD indicator settings for day trading, using the '2-line MACD' can greatly benefit different trading strategies.

It's worth mentioning that some programmers can code a MACD trading strategy with Python. However, predicting the markets with programs can be very difficult to do accurately, so this article will cover MACD trading strategy based on studying the charts and using EMA lines and some other indicators.

Indicator settings for the MACD trading strategy

There are many different parameters for the MACD indicator. Here are the main ones:

  • The fast and slow MA. With a greater difference between their periods, the histogram will show more rapid changes. Most often, you will leave these parameters at default (though some specific strategies require other parameters).
  • MACD SMA is a parameter within the MACD moving average itself. If you set this parameter higher, the average will move further away from the histogram, which means they will intersect less often. If you set the parameter value higher, there will be fewer signals.
  • Next, you need to set the open, close, and the candlestick's highest and lowest values.
  • Lastly, there are the minimum and maximum parameters.

Certain parameters, such as levels, will be required for different strategies. Let’s look at some specific ways to use the MACD indicator and what the best MACD indicator settings for day trading are.

Simplest MACD strategy

A simple MACD trading strategy is called the Signal Line Crossover, or MACD crossover trading strategy. This method works well in volatile markets with strong trends, such as 2x and 3x ETFs and tech stocks.

The Signal Line is just an EMA of the MACD Line for 9 periods. Since it is a MACD line average, it follows behind the formation of the MACD line. A bullish crossover happens when the MACD line turns upwards and crosses beyond the signal line.

A bearish crossover happens when the MACD turns downwards and crosses under the signal line. When this happens, you want to be sure both lines move as far apart from each other as they can. This can signal that the momentum of the price will continue moving in the desired direction.

Using the MACD by searching for a crossover is a common MACD trading strategy.

MACD Divergence

Understanding MACD convergence divergence (sometimes called the MACD divergence trading strategy) is very important. When the price is making a lower low, but the MACD is making a higher low – we call it bullish divergence. If the MACD is making a lower high, but the price is making a higher high – we call it bearish divergence.

Divergence will almost always occur right after a sharp price movement higher or lower. Divergence is just a cue that the price might reverse, and it's usually confirmed by a trendline break. These can be crucial for a MACD swing trading strategy.

With the best MACD indicator settings for day trading, understanding MACD convergence divergence can greatly enhance a trader's strategy. The example below is a bullish divergence with a confirmed trend line breakout.

Depicted: An Example of a Confirmed Break - EUR/USD Hourly Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Depicted: Example of a Bearish Divergence With a Trendline Breakout - EUR/USD Hourly Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

MACD Indicator Settings for Intraday Trading

The MACD can be used for intraday trading with the default settings (12,26,9). However, if we change the settings to 24,52,9, we can construct a system with one of the best MACD settings for intraday trading that works well on M30. The intraday trading system uses the following indicators:

  • Smoothed Moving Average (SMA) (365, close)
  • MACD (24,52,9)
  • Williams Percent Range (28)

The system is traded on 30-minute time frames, and it is suitable for trading major Forex currency pairs such as: EUR/USD, GBP/USD, USD/JPY, USD/CHF, AUD/USD, and other currency pairs like: GBP/JPY, AUD/JPY, USD/JPY, NZD/JPY, and GBP/NZD.

Depicted: EUR/USD M30 Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

The rules are as follows:

Long Trades:

  • The price should be above the SMA
  • The MACD should be below the 0 line
  • The William % Range should be crossing -80 from below

Short Trades:

  • The price should be below the SMA
  • The MACD should be above the 0 line
  • The William % Range should be crossing -20 from above.

As you can see from the examples above, with the best MACD settings for day trading, the MACD is used in a completely different way than what you might have read on the Internet. The reason being – the MACD is a great momentum indicator and can superbly identify retracement.

Don't forget the basic principle of trading – in an uptrend, we buy when the price has dropped; in a downtrend, we sell when the price has rallied. This is exactly what the MACD is pinpointing at – when the price is ready to be sold and/or bought. Trading with the MACD should be a lot easier this way.

Trading With A Demo Account

Traders also have the ability to trade risk-free with a demo trading account. This means that traders can avoid putting their capital at risk, and they can choose when they wish to move to the live markets. For instance, Admiral Markets' demo trading account enables traders to gain access to the latest real-time market data, the ability to trade with virtual currency, and access to the latest trading insights from expert traders.

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MACD with the RSI and SMA

I will now show you how to use the MACD with the Relative Strength Indicator (RSI) and the Simple Moving Average (SMA). This is sometimes called the MACD and RSI trading strategy. First, let's look at each one individually.

RSI Indicator

The RSI indicator is used by traders to measure the strength of a trend and to identify possible reversal points. It consists of two levels - oversold and overbought - and a 14-period baseline. These levels are set at 20 and 80 or 30 and 70, depending on the strategy of the trader. Setting the indicator at 20 and 80 is considered more conservative. In this case, the indicator is less sensitive to fluctuations in the price and can potentially show stronger indications. However, it depends on the personal preference of the trader.

SMA Indicator

An SMA indicator calculates the average of a specified price range, usually between closing prices, measured by the number of periods within that range. An SMA is a technical indicator that can help a trader discern if a price trend will continue or reverse.

MACD + RSI + SMA

This combination uses one leading (RSI) and two lagging (MACD and SMA) indicators. The RSI shows the potential future price changes. The SMA is a trend-following indicator that lags. While the RSI shows potential reversal points, the SMA helps in confirming these signals.

The MACD, meanwhile, helps reveal the trend's strength and direction. Traders use the MACD, in this case, to confirm the first two signals of the RSI and SMA. So, how can we read each signal and use these indicators together? Let’s look at an example:

The baseline of the RSI could be above 50 and continuing upwards, while the candle chart is crossing over the SMA line from underneath and moving above it. Meanwhile, the MACD is also showing a BUY signal: this, in general, would be a buy signal. 

A Selling signal would materialize if the candlesticks were falling below the SMA line, the baseline of the RSI was shifting towards oversold and the MACD was producing red bars while the blue line was moving down, crossing over the orange line.

Scalping With the MACD Indicator

There are different settings that constitute the best MACD settings for day trading. In this particular scalping system, you will use the MACD on different settings. This strategy uses the Stochastic Oscillator. Some traders refer to it as a MACD and Stochastic trading strategy. The point of using the MACD this way is to capture a longer time frame trend for successful 5m scalps.

Indicators:

  • EMA 34 (Blue)
  • EMA 55 (EMA)
  • MACD (34,89,34)
  • Stochastic Oscillator (8,1,3 and 13,1,3), overlaid

Time frame: 5m

Pairs: EUR/USD (focus), GBP/USD, GBP/JPY, USD/JPY, AUD/USD, EUR/JPY, USD/CHF

Long entries:

  • The Blue 34 EMA should be above the Red 55 EMA
  • The MACD should be above the 0 line
  • The Stochastic (at least one of them) should be recently oversold at the 20 level, and should be crossed up

Short entries:

  • The Blue 34 EMA should be below the Red 55 EMA
  • The MACD should be below the 0 line
  • The Stochastic (at least one of them) should be recently oversold at the 20 level, and should be crossed up

Depicted: An Example for Short Entries - EUR/USD M5 Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Depicted: An Example for Long Entries - GBP/JPY M5 Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

In the context of scalping, these are some of the best MACD settings for day trading. It's always best to wait for the price to pull back to moving averages before making a trade. 

MACD Patterns

When we apply 5,13,1 instead of the standard 12,26,9 settings, we can achieve a visual representation of the MACD patterns. These patterns could be applied to various trading strategies and systems, as an additional filter for taking trade entries. It is argued that the best MACD setting for a MACD pattern is 5,13,1.

MACD Bullish SHS

This is a Bullish SHS (Inverted Head and Shoulders pattern) that marks a reversal, and a possible turn to an uptrend. A possible entry is made after the pattern has been completed, at the open of the next bar.

MACD Bearish SHS

This is a Bearish SHS pattern (Head and Shoulders) that marks a reversal and a possible turn to an uptrend. A possible entry is made after the pattern has been completed, at the open of the next bar.

MACD Bullish Continuation

A bullish continuation pattern marks an upside trend continuation. First, the MACD makes a downside turn from point A, marking a retracement. Subsequently, when point A is broken by the MACD histogram, it is a signal for a long entry.

MACD Bearish Continuation

A bearish continuation pattern marks an upside trend continuation. First, the MACD makes an upside turn from point A, marking a retracement. Subsequently, when point A is broken by the MACD histogram, it is a signal for a short entry.

MACD Bullish 0 Line Rejection

When the MACD comes down towards the Zero line and turns back up just above the Zero line, it is normally a trend continuation move. Points A and B mark the uptrend continuation.

MACD Bearish 0 Line Rejection

When the MACD comes up towards the Zero line and turns back down just below the Zero line, it is normally a trend continuation move. Points A and B mark the downtrend continuation.


Depicted: Examples As Seen On The Charts - GBP/JPY Hourly Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Depicted: GBP/JPY Hourly Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Bear in mind that the best time frame for the MACD patterns is H4. By using MACD the right way, you should hopefully empower your trading knowledge and bring your trading to the next level! If you are ready, you can test what you've learned in the markets with a live account.

If you need some practice first, you can do so with a demo trading account. Demo trading accounts enable traders to trade in a risk-free trading environment, whereby traders use virtual funds so that their capital is not at risk.

MACD and Stochastic: The Double Cross Strategy

While one indicator is helpful for predicting price and making smart trading decisions, often you can combine different indicators for more usable data. Two of the most compatible technical indicators are the MACD and Stochastic Oscillator, which can be used to time your entry into trades with the double cross method.

Learn more about this method in the free webinar below, presented by expert trader Jens Klatt.

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of, or recommendation for, any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks

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