7-21 MACD Divergence Forex Trading Strategy

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7-21 MACD Divergence Forex Trading Strategy

Traders are always on the hunt for trade setups that would allow them to earn as much pips as possible. This is why traders would always look to trade at the beginning of a new trend or momentum and would try to exit as the trend is about to end. These kinds of trades are common during trend reversal setups. Trend reversals provide traders the opportunity to earn huge profits because trades are usually opened near the start of a trend and closed as the trend ends. However, trend reversals are very difficult to anticipate. Many traders compare it to “catching a falling knife”.

Trading should not only be about taking high yielding trades. Instead, it should be a mix between good risk-reward ratios and high win probabilities. There are traders who instead of anticipating a trend reversal, would rather aim to anticipate the next price swing. Although anticipating price swings is also not easy, there are ways traders can anticipate the next price swing with a relatively high degree of confidence.

One of the most effective ways traders anticipate price swings and reversals is by observing for divergences.

Divergences are discrepancies in the intensity of a swing between price action and an oscillator. This means that the height or depth of a swing high or swing low in price action varies from the peak or trough on the oscillator. These scenarios indicate that there is a high probability that the market would reverse. The chart below shows us what divergences look like.

7-21 MACD Divergence Forex Trading Strategy - Divergence Cheat Sheet

2 Line MACD

2 Line MACD is a momentum indicator which is based on the Moving Average Convergence and Divergence (MACD).

The MACD is an oscillator which is based on the convergence and divergence of moving averages. It is arrived at by finding the difference between two moving average lines. The result is then plotted as an oscillator on a separate window. This line is called the MACD line. Then, a signal line is derived from the main MACD line. The signal line is basically a moving average of the MACD line.

Directional bias can be identified based on whether the two lines are positive or negative. Positive lines indicate a bullish directional bias, while negative lines indicate a bearish directional bias.

Trend reversals can be identified based on the crossing over of the MACD line and the signal line. A bullish reversal may occur if the MACD line crosses above the signal line. Inversely, a bearish reversal may occur if the MACD line crosses below the signal line.

The 2 Line MACD indicator is a modified version of the MACD which attempts to decrease the lag which is present in the classic MACD line.

EMA Crossover Signal

One of the ways traders anticipate a trend or momentum reversal is by looking at moving average crossovers. Traders would anticipate a bullish reversal whenever a faster moving average line crosses above the slower moving average line. Traders would also anticipate a bearish reversal whenever a faster moving average line crosses below a slower moving average line.

Moving average crossovers are effective. However, most moving average crossover signals are lagging.

EMA Crossover Signal attempts to decrease the lag by using an underlying Exponential Moving Average (EMA) as a basis for its signals. This is because EMAs tend to have less lag and are more responsive to price changes.

The EMA Crossover Signal indicator conveniently plots an arrow pointing the direction of the reversal whenever it detects one.

Trading Strategy

7-21 MACD Divergence Forex Trading Strategy is divergence trading strategy that aims to trade on swing points based on the 2 Line MACD oscillator.

First, we should observe for divergences that would occur between the swing points in price action and the peaks and troughs in the 2 Line MACD indicator. It could either be a regular or a hidden divergence.

Then, after the divergence is confirmed, we should then wait for the EMA Crossover Signal indicator to plot an arrow signaling the reversal.

A confluence between a divergence and the signal from the EMA Crossover Signal indicator would confirm a valid trade setup.

Indicators:

  • EMA Crossover Signal
    • Faster EMA: 7
    • Slower EMA: 21
  • 2line_MACD

Preferred Time Frames: 1-hour, 4-hour and daily charts

Currency Pairs: FX majors, minors and crosses

Trading Sessions: Tokyo, London or New York sessions

Buy Trade Setup

Entry

  • A bullish regular or hidden divergence should be observed between price action and the 2 Line MACD indicator.
  • The EMA Crossover Signal should plot an arrow pointing up.
  • Enter a buy order on the confluence of the conditions above.

Stop Loss

  • Set the stop loss on the support below the entry candle.

Exit

  • Close the trade as soon as the EMA Crossover Signal indicator plots and arrow pointing down.

7-21 MACD Divergence Forex Trading Strategy

7-21 MACD Divergence Forex Trading Strategy 2

Sell Trade Setup

Entry

  • A bearish regular or hidden divergence should be observed between price action and the 2 Line MACD indicator.
  • The EMA Crossover Signal should plot an arrow pointing down.
  • Enter a sell order on the confluence of the conditions above.

Stop Loss

  • Set the stop loss on the resistance above the entry candle.

Exit

  • Close the trade as soon as the EMA Crossover Signal indicator plots and arrow pointing up.

7-21 MACD Divergence Forex Trading Strategy 3

7-21 MACD Divergence Forex Trading Strategy 4

Conclusion

Trading on divergences has been proven to be an effective and profitable trading strategy. MACD divergences in particular are one of the most widely used trading strategies. There are traders who have reported being profitable at around 60% to 70% of the time using MACD divergences.

This MACD divergence strategy makes use of a MACD indicator which produces lesser lag compared to the basic MACD. This allows the strategy to produce trade setups that have a very high win probability.

The key to profiting from this strategy is in identifying the correct swing points in price action and comparing it to the peaks and troughs in the 2 Line MACD indicator. It may take time to master identifying the right swing points, but traders who can develop this skill can profit regularly from the forex market.

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