Technicals | May 03 2013
By Walker England, Forex Trading Instructor
Identifying and trading changes in the trend can be one of the hardest skills for a trader to master. However, by having knowledge of technical analysis and indicators, traders can successfully navigate a market turn. Today we will focus on analyzing the MACD (Moving Average Convergence Divergence) indicator and using it to our benefit in a changing market environment.
The EURGBP pictured below, is an excellent example of how MACD can be used in such environments. The EURGBP has had extended gains moving as much as 1063 pips from its March 2012 low at .7751. At the same time, it should also be noted the pair has also recently turned from its 2013 high and has declined as much as 417 pips. So how can we use MACD to navigate this changing market climate?
The first step to trading a market turn is to identify MACD Divergence. Divergence normally occurs when the indicator is moving in a different direction from price. Below we can see EURGBP forming a higher high, while MACD divergence is making a lower high. This is our first indication that price is attempting to turn from the trend. At this point, traders should consider concluding any existing long positions and begin looking for momentum to turn on the pair.
Next, traders will use MACD to identify what is known as a zero line crossover. The zero line represents momentum for a currency displayed using the MACD indicator. When MACD moves below the zero line, as in the example below, it indicates that the 12 period EMA has moved below the longer 26 period on our graph. This movement will confirm the momentum shift pinpointed by divergence and will allow traders to begin identifying new sell positions.
Lastly, once divergence and momentum has been identified traders can then look for execution using a classic MACD crossover. Traders will look to sell the new downtrend when the red MACD line crosses below the blue signal line in a downtrend. Traders can then repeat this approach until markets again diverge and the process can be replicated with the new directional trend.
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