When the market explodes out of a channel,
either rising above resistance or dropping below support, use the momentum
technique with the MACD. This is generally a position trade, lasting several
days or even a month. While you'll pay a small overnight renewal fee (with most
brokers) to keep the trade active, these trades generally bring in enough pips
to make holding the position well worth your while.
Moving Average Convergence/Divergence (MACD)
is a popular indicator that works well in momentum markets. MACD (pronounced
mac-d) plots three different exponential moving averages, and displays them as
two lines of different colors that criss-cross atop the chart itself or within
the window below it. One line is the MACD itself; the other is called the
signal or trigger line.
The MACD also plots a histogram, which is a
sort of bar chart in the window below the currency pair's price chart. On the
MACD histogram, there is a line that signals the zero point, called the
centerline, and the bars of its chart rise and fall above and below that
centerline like a wave. The histogram illustrates the difference between the
MACD line and its signal line; when they cross each other, the histogram will
read zero.
If your software platform wants you to set
the configuration of the MACD, the most popular settings are 12 and 26 for the
indicator itself and 9 for the signal line. Experiment to find what works best
for you and your own trading style.
Like the RSI, MACD can indicate when a
currency pair is overbought or oversold. There's no specific number to indicate
this, but when the lines of the histogram get really long, that's a good hint
that a reversal could be near.
Again like the RSI, MACD can indicate
divergence. When the price reaches a new high or low but the MACD line doesn't,
that could mean the momentum is weakening. Again, a reversal could be near.
The technique
When the MACD crosses its signal line, that's
an entry signal in the direction the MACD line is going. If it falls below its
signal line, look to see if a short trade is feasible; if it rises above it, go
long. This signal is considered especially strong if, shortly after the
crossover happens, the price of the currency pair breaks above resistance or
below support; that could signal a big move.
Be aware that the MACD is a lagging
indicator, so its signals won't call the absolute highs and lows for you. That's
why it's not helpful in a range-bound market: if you base your entry points
only on the MACD, by the time the indicator catches up to the current price,
the price may have risen or fallen so far within the channel that there's no
longer enough of a trade left to be profitable.
When using the MACD in a momentum market,
where price has broken through support or resistance and is reaching new highs
or lows, the MACD signals may start showing divergence, indicating the trend is
weakening when perhaps it really isn't. In that situation, watch the price
chart itself, and compare what it is telling you to what the indicators show.
For example, let's say the GBP/USD has broken
out above resistance and is reaching new highs. The MACD signaled the break by
crossing over its trigger line, but as the price continues to rise, the MACD
doesn't reach new highs, indicating divergence, and you wonder if the trend is
weakening. Meanwhile, the price continues to rise.
Should you bail out? No. Watch the chart.
As the GBP/USD continues to rise, it will
fluctuate in short- and intermediate term trends, going down a bit then rising
again. This is called market jitters, or swing lows (if the currency pair was
falling, they would be called swing highs). Don't let it bother you; it's
perfectly normal.
Notice that each new swing low is higher than
the one before. The market doesn't swing down so much that the long-term trend
changes; it just retraces itself for a while, then resumes its climb. It looks
rather like someone dribbling a basketball up a hill, each dribble higher than
the one before. (You do, of course, have your stop set far enough away that the
swings don't trigger it and kick you out of a profitable trade. Hopefully your
broker offers a trailing stop, so it rises to follow as the price goes up,
locking in your profits.)
Wait for that pattern to change. When a swing
low goes lower than the previous one, that's the bail-out point. Close your
trade, then sit back and calculate your profits.
