Technicals | Nov 29 2012
By Walker England, Trading Instructor
Traditionally traders look to the MACD indicator for its signal line crossovers to identify swing trade entries. While these indicator movements are useful, traders often overlook the imbedded divergence signals that are hidden inside of MACD. If traders know what to look for they can look for, they may use MACD with traditional divergence to spot potential market reversals in the Forex market.
The chart below is an excellent example. The EURJPY has now moved 1061 pips higher after concluding a 1732 decline on the daily chart. Could MACD spot the reversal? To find out, let’s investigate MACD further and its role in spotting traditional market divergence.
(Created using FXCM’s Marketscope 2.0 charts)
What is divergence? Divergence is a market term that indicates that price is separating from the direction of an indicator. In a downtrend, traders will expect that price will moving lower. Since an indicator is nothing more than a representation of what is occurring on the graph the general expectation is for the indicator to do the same. Divergence occurs when an indicator splits from an indicator and they begin heading in two different directions. Let’s look at our example below, again using a EURJPY daily graph.
In a downtrend, we need to begin our analysis by comparing the declining swing lows on the graph. In our EURJPY example we will be comparing the June 1st and July 24th lows, at 95.57 and 94.10 respectively. It is important to note the dates of these points as we need to compare the lows of the MACD indicator as well. Marked on the chart below, we can see MACD making a series of higher lows during the same time period. This is the traditional divergence we are looking for! Once spotted, traders can begin looking for a potential trend change and employ the strategy of their choosing.
(Created using FXCM’s Marketscope 2.0 charts)
Traders should always remember that markets can remain trending for extended periods of time, and that picking trend changes can be very difficult. As with any strategy traders should always use a stop to contain their risk. One method to consider is the use of a tailing stop. In the event of a trend change, traders can continue to lock in profits as a set trail moves forward.
The views expressed are not FNArena's (see our disclaimer).
For real time news and analysis, please visit http://www.dailyfx.com/real_time_news
DailyFX provides forex news on the economic reports and political events that influence the currency market. Learn currency trading with a free practice account and charts from FXCM.
www.dailyfx.com
Disclaimer
Forex Capital Markets is headquartered at Financial Square 32 Old Slip, 10th Floor, New York, NY 10005 USA.
Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before you decide to trade the foreign exchange products offered by Forex Capital Markets, LLC, Forex Capital Markets Limited, inclusive of all EU branches, FXCM Asia Limited, or FXCM Australia Limited, any affiliates of aforementioned firms, or other firms under the FXCM group of companies [collectively “FXCM Group”] you should carefully consider your objectives, financial situation, needs and level of experience. If you decide to trade foreign exchange products offered by FXCM Australia Limited you must read and understand the Financial Services Guide and the Product Disclosure Statement. FXCM Group may provide general market information and commentary which is not intended to be investment advice and the content of this email must not be construed as personal advice. By trading, you could sustain a total loss of your deposited funds and therefore, you should not speculate with capital that you cannot afford to lose. You should be aware of all the risks associated with trading in foreign exchange products. Foreign exchange products are only suitable for those customers who fully understand the market risk. FXCM recommends you seek advice from a separate financial advisor.
FXCM Group assumes no liability for errors, inaccuracies or omissions in these materials and does not warrant the accuracy or completeness of the information, text, graphics, links or other items contained within these materials. FXCM Group shall not be liable for any special, indirect, incidental, or consequential damages, including without limitation losses, lost revenues, or lost profits that may result from these materials. This email is not a solicitation to buy or sell currency. All information contained in this e-mail is strictly confidential and is only intended for use by the recipient. All e-mail sent to or from this address will be received by the FXCM corporate e-mail system and is subject to archival and review by someone other than the recipient.”
Technical limitations
If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.