Weekly Trading Lesson: The Moving Average Convergence/Divergence (MACD)

Developed by Gerald Appel, Moving Average Convergence/Divergence (MACD) is one of the simplest and most reliable indicators available. It is calculated by plotting the difference between two moving averages and then adding another moving average to the difference. Like most technical indicators, these tools are meant to help us time our entry rather than predict where the market will go. Here is a daily chart of the USD/JPY with an MACD plotted with the common values of 12,26,9. You can see that the crossovers of the MACD line and the MACD Signal Line, which is the moving average of the MACD, offered good entries for selling opportunities. However, the key here and with all technical indicators is that we are only taking the sell signals since the direction of the daily trend is down. So we look to sell rallies up to a resistance level in this downtrend. After that happens, we can see the crossover and the subsequent selling pressure which could have led to winning trades. One of the keys to increasing your chance of success on these setups is to place your protective stop above the high after entry and then to look for twice that risk in profit potential for your 1:2 risk:reward ratio. If you are risking 100 pips, look for at least 200 pips in profit. These setups on the daily chart can be solid about half of the time, so you have to make sure the losing trades do not keep you from being profitable in the long run. Using a 1:2 risk:reward ratio can be the difference.