By Sean Hyman As I’m sure you know, every Forex trader uses different tools to predict where the Forex markets are heading next. I personally have two main technical indicators I use to choose my Forex trades. One is the “slow stochastic” I introduced you to last week.

The other is called the “MACD” indicator, or Gerald Appel’s Moving Average Convergence Divergence.

MACD also happens to be one of the most widely used technical indicators in the world at the moment. It’s also one of the most misunderstood – even though it dates all the way back to the 1960s.

Technically, MACD is just a momentum indicator that shows the relationship between two prices on a chart. In our case, we’re looking for the relationship between two currency trend lines on the chart.

Before the advent of the personal computer, most technicians had to manually calculate these trend lines, and then chart them on graph paper. Today, you can just click on your trading platform and you’ll see it automatically! Needless to say, it’s nice to live in the 21st century.

Let’s talk about MACD for a moment, so you can use it in your own trading. First, take a look at the chart below. There are three main ways to use the information you’re seeing…

Three Signals Wrapped into One!

The first way that the MACD is used is the “crossovers.” Take a look at the bottom of this chart. Those wavy green and blue lines at the bottom indicate the MACD. When the two lines go down and then cross and turn higher, you have a buy signal for a particular currency pair (as seen in the blue boxed area).

When the two wavy lines head higher and then cross over and turn downward, you have a sell signal (I circled this point in red above).

Tip for Using Crossovers: The best way to use these buy and sell signals is to ONLY enter a position when your position is in line with the prevailing trend direction at the time. For example, if the prevailing trend is heading higher, then I would take a buy position. If the trend is heading lower, you should only look for sell signals.

The second way that the MACD can give a signal is by “divergence.” Divergence is when the price heads one way and the indicator heads in the opposite direction. I copied the same chart below so you can take a look again. I’ve indicated the divergence with the black lines.

You will notice that while the price continued to head lower, the MACD started to rise and “buck” this trend.

Divergence Gives You a Heads Up About a
Coming Change in the Trend

While divergence doesn’t mean to immediately take an opposing trend trade, it does indicate that the present trend is weakening. That usually leads to an eventual change of trend all together.

Tip for Using Divergence: The best way to use divergences is to allow them to give you a “heads up” about a trend change that is coming soon. This will get you ready for the upcoming change. It may cause you to lighten your present position or even slowly close out some of your position over time.

However, you should only ACT upon the divergence when the trend line is broken. That way you can be sure the divergence is actually happening. It has to prove itself. You don’t want to hop out too early just because you see a divergence coming. So wait until it happens before you close out completely.

The third way you can use MACD is to watch for when the lines go BELOW and back ABOVE the zero line (as noted by the black boxed areas). The zero line is where the smaller red bars flip from negative bars to positive bars, etc.

It’s helpful to think of the MACD zero line as the point of no return for a currency pair. When both MACD lines fall below the zero line, it’s like putting ankle shackles on a currency pair. It’s going to fall. First you’ll see the pair’s price start to dip, and then you’ll see a lot of short-sell crossover signals coming for that pair.

However, when the two MACD lines come back up above the zero line to the right of the chart, it’s like those ankle shackles are stripped off of the pair. That currency pair can finally fly higher once again. This is a time when buy crossover signals seem to have their largest impact.

Avoid These MACD Mistakes!

The biggest way traders mess up with this indicator is…to take “any and every” crossover signal no matter what the prevailing trend direction is. If you simply wait to enter the pair whenith the signal goes “with” the trend and not against it, then you will have so much better results.

The second biggest way I see traders mess up using this indicator is to take divergence as an IMMEDIATE signal to take a counter trend trade. Remember, counter trend trades are always low probability trades. Trends tend to last longer than any of us think they will, so you’ll lose a lot of money if you’re not patient with divergences.

Allow the trend line to break in the way that the divergences suggests before entering. Then you’ll be “with” the trend direction and have a high probability trade.

I hope this has shed a little light on the MACD indicator. I’ll be back soon with more trader tips and secrets.

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