MACD Divergence: Number 1 Forex Divergence Indicator

Picture of arrows pointing in opposite directions suggestive of best forex MACD divergence indicator.

Hi friend!  If you are seeking the world’s best forex indicators, don’t look beyond MACD, one of the most popular forex technical indicators in forex trading.

I have devoted this blog post to MACD, one of my favourite indicators, and have entitled it MACD Divergence: Number 1 Forex Divergence Indicator accordingly. 

This is one of the best momentum indicators.  Look no further.

Forex Tip

For The Shotgun Trade and forex swing trading, you only need three indicators – MACD and the 50 and 200 Exponential Moving Averages.

For forex scalping, Bollinger Bands and RSI will do the trick.

Please refer to my blog post Forex Trading Techniques for further details.

Table of Contents:

Forex Tip
MACD Basics Background
MACD Divergence
MACD Histogram Divergence
MACD Inverted Divergence
Quiz
Unsolicited Testimonial
British Pound Flash Crash
Forex Time Zones
Flash Crash 1 Hr. Chart
Risk Management
TradingSmarts Wins Awards
Uber Forex Broker
Quotes
References
Forex Tools
Conclusion

MACD Basics Background

Number One in My Books

Picture of star-shaped yellow image with word MACD in middle highlighting that best forex indicator

A word on MACD… MACD is appreciated for the fact that it is effectively two indicators in one – MACD, and then there’s the MACD Histogram.

Not only that, but you don’t really need any other indicators, other than perhaps forex pivot points and an exponential moving average like the 50 and also the 200 (only Bollinger Bands and RSI, if you’re into forex scalping).

Developed by Gerald Appeal in 1979, MACD stands for MACD Average Convergence Divergence.  This oscillator is one of the most effective and simplest momentum indictors.

It is effective at identifying the direction, strength, or weakness of the underlying momentum of a tradable’s move.  In a perfect world, momentum is positive (bullish) when MACD is above its waterline (center line), and negative (bearish) when it is below its center line.

Is MACD a good indicator?  MACD has gone on to earn the reputation of being one of the most popular forex technical indicators in forex trading.  As to how does the MACD work, let’s get into that now.

MACD is pure genius because it handles a number of functions, including signalling trades by penetrating its trigger line, and by diverging to price action.

In addition, MACD is multi-faceted in that it includes an indicator within an indicator.  The MACD Histogram will at times throw off an early warning of a shift in price direction, even before MACD itself does.

Moving average convergence divergence (MACD) is defined as a trend-following momentum indicator, showing two moving averages of prices and the relationship between the two.  MACD is derived by taking the 12-day EMA and subtracting the 26-day exponential moving average (EMA) from it.

The ‘signal line’ is a nine-day EMA of the MACD.  It is superimposed on top of MACD, and functions as a trigger to generate buy and sell signals.

In forex trading, the most powerful signal generators are MACD divergence, MACD histogram divergence, MACD inverted divergence, and the trigger line.

With regards to EMAs, an exponential moving average (EMA), aka exponentially weighted moving average, is a moving average similar to a simple moving average – the difference being that the latest data on price performance is emphasized more. 

That is, it is more responsive to recent changes in price than the simple moving average.

As I stated in the forex tip above, I prefer to use the 50 EMA and the 200 EMA, in addition to MACD.  As an aside, some years ago traders were asked which of the 99 indicators was number one in their books.  The answer was a resounding the 200 EMA which is, incidentally, the trend indicator.   

Just a quick note here… I hear people asking me all the time how to fine tune the settings for MACD.  My answer quite simply is to just leave the settings alone.  The standard settings do the job quite nicely.

The same holds true for any of the other indicators.  Once you achieve forex wealth from your forex trading, then you can fool around with the settings.  Till then, leave well enough alone.

Anyway, I’m getting ahead of myself.  Presumably by now you have taken a look at the forex tip and the Table of Contents above.  It’s now time to dive right into the meat of this blog post on understanding MACD.

I hope you now have a firm grasp on what MACD is all about and its basic precepts.  You don’t have to understand all the techno babble I have just thrown at you.  Just pay attention to what lies ahead, and the fog will clear.

I’m not going to get into a lot of fluff talk that sucks, like the stuff you see on other sites, where the information has been ripped off from who knows where.  My stuff is the real deal – based on sixteen-plus years of being involved with the forex.    

Please study all of the forex trading charts that follow, where you will get a real education in MACD divergence, MACD histogram divergence, and MACD inverted divergence – the best forms of forex divergence.

A picture is worth 1,000 words.  The following MACD concepts will open your eyes as to what is possible with your forex trading, as you plan your MACD divergence strategy.

Let’s get right into it…

MACD Divergence

Picture of arrows pointing in opposite directions suggestive of best forex MACD divergence indicator.

In the following forex trading charts, I have shown examples of both negative divergence and positive divergence. 

In the first chart, you can see both types of MACD divergence.  Both forms of divergence resulted in a correction in price direction. 

Where you see price cycling lower, and MACD waving higher, price rises.  This is positive divergence, and is denoted by drawing lines underneath price action and beneath the MACD waves.  You can see what I mean in both charts below.

Regarding negative MACD divergence, price cycles higher, while MACD waves lower.  Accordingly, price swoons.  Here, you draw lines above price action and above the MACD waves.

I have included an example of MACD histogram divergence over to the right, but I’ll get into that in a minute.

GBPUSD forex chart showing positive and negative MACD divergence and its effect on price direction

(Chart via ProRealTime.com)

EURUSD forex chart showing another example of positive MACD divergence & its effect on price action

(Chart via ProRealTime.com)

MACD Histogram Divergence

Picture of colourful arrows curved in opposite directions with words MACD Histogram Divergence on it

Getting back to the first chart in the section above on MACD divergence, you can see where I have highlighted MACD histogram divergence over to the right.  I have repeated that chart below.

This is where we see the indicator-within-an-indicator aspect of MACD.  That’s what makes this oscillator so much more powerful.

Notice how this time I have drawn lines above price action and the histogram itself (the green upright bars).  You can see what happened to price.  Down she went.  Who could have guessed?

Now that you know what MACD divergence proper looks like (refer back to the first section above), see if you can spot another instance of that kind of divergence in the chart below.

For the answer, please look at the same chart right below it, where I have drawn in the appropriate lines.  

This is still considered to be negative MACD divergence to price, even though the lines ended up being perfectly horizontal in both cases (above price and above MACD).  The effect was the same on price.  Price had formed a double top, and MACD responded in kind.  Pretty cool, eh?

GBPUSD forex chart showing example of negative MACD histogram divergence and its effect on price

(Chart via ProRealTime.com)

GBPUSD forex chart showing another example of MACD divergence and its effect on price action

(Chart via ProRealTime.com)

Okay, here we have (below) a case of positive divergence on MACD histogram to price.  All the while price was tanking, the histogram waved at the same level.  You can see what happened to price.

GBPUSD forex chart showing example of positive MACD histogram divergence and its effect on price

(Chart via ProRealTime.com)

The chart below will strain your eyes, because there are quite a few instances of forex divergence.

Let’s have at it…

The instances of MACD histogram divergence are pretty obvious.  I have marked the four occurrences with an asterisk.

I have also noted an example of inverted divergence, which we’ll get into in the next section.

If you’re still struggling with being able to ascertain where the various forms of divergence are on a chart, I have a test coming up after the next section that will hopefully make them clearer for you.

EURUSD forex chart showing 4 examples of MACD histogram divergence and its effect on price action

(Chart via ProRealTime.com)

MACD Inverted Divergence

Picture of sign with arrows pointed in opposite directions with words Inverted Divergence on it

EURUSD forex chart showing 1 example of positive inverted divergence and its effect on price action

(Chart via ProRealTime.com)

This form of divergence may be a little bit more difficult to get your head around.  I know it took me quite a while to be able to see it on the fly.  Even now, I have to think long and hard before it pops off the chart and smacks me in the face.

So, what exactly is inverted divergence?  Please have a look at the ‘Types of MACD Divergence to Price’ diagram following the next two charts that illustrate what it is all about.

In addition to the chart above, the charts that follow show two more examples of this type of forex divergence.

I couldn’t find any negative inverted divergence, so we’ll stick with positive inverted divergence for now which is essentially, as you can see, a situation where price is cycling higher, and MACD is waving lower.  The result is price advancing.

USDCHF forex chart showing 1 example of positive inverted divergence and its effect on price action

(Chart via ProRealTime.com)

GBPUSD forex chart showing 1 example of positive inverted divergence and its effect on price action.

(Chart via ProRealTime.com)

Diagram of 4 types of MACD divergence to price, bullish and bearish, showing effect on price action

Quiz

Picture of question mark with question if you can see MACD divergence and histo divergence on chart(Chart via ProRealTime.com)

(Chart via ProRealTime.com)

Please have a look at the chart above, and see if you can spot the two instances of both MACD divergence and MACD histogram divergence occurring together.  The first is negative divergence to price, and the second positive divergence to price.

Picture of sign saying answers to quiz on MACD divergence and histo divergence are on next chart.

USDJPY forex chart with 2 examples of MACD divergence and histo divergence neg and pos back-to-back

(Chart via ProRealTime.com)

As noted on the chart above, you can clearly see the two types of MACD divergence back-to-back – negative divergence (MACD and histogram) to price and positive divergence (MACD and histogram) to price.

There you have it my friend… you are now an expert in MACD divergence, MACD histogram divergence, and MACD inverted divergence – the three types of forex divergence with the MACD indicator.

Unsolicited Testimonial

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British Pound Flash Crash

Words Flash Crash superimposed on chaos background.  Flash crash & black swan are unexpected events.

In my last blog post on forex pivot points, I talked about the institutional investors being extremely long the British Pound, and that it looked like the pound was on its way up on the daily chart. 

I could not have anticipated what was about to come next (shortly after I published that blog post) – the ‘British Pound Flash Crash October 6/16.’  There are no indicators, including the three forms of forex divergence – MACD divergence, MACD histogram divergence, and MACD inverted divergence, that could have predicted this sort of event.

The net effect was the breathtaking plunge of the pound from 1.2614 to 1.1472 in a heart beat.  I suspect some forex traders got hurt pretty badly in the process.

So, let’s explore what that flash crash was all about…

The flash crash of the British pound occurred Thursday night, Oct. 6/16 (Friday morning in Tokyo).  As a matter of fact, it occurred at the Tokyo open forex session.  For other sessions, please refer to the screen shot below this narrative.

A flash crash is defined as a deep, rapid, and volatile fall in market prices within a very short period of time.  It can stem from trades initiated by ‘black- box trading,’ together with ‘high-frequency trading.’

The loss and recovery of billions of dollars in a split second can be the net effect of the speed and interconnectedness of the computerized trading environment we have available to us today.

On the equity side of things, long gone are specialists who used to keep markets orderly.  Their role was viable when the bid and ask spread was wide enough for them to profit from being on the other side of trades.

The main reason we are seeing a rise in the number of flash crashes is the fact that there is no longer any economic benefit for them to be out there in front of a huge market order.

Computer algorithms (aka ‘algos’) are driving black-box and high-frequency trading.  Most traders ultimately use these trading styles to route orders to the exchanges, which are coded to make money for the users.

I guess you could call these algorithms ‘smart algos,’ given their ability to widen their bids and asks, or completely disappear, when volatility spikes due to earnings updates, geopolitical risk, headline news, and unpredictable events, such as ‘black swans’ or ‘fat finger trades.’

When the algos kick in like that during these periods of illiquidity, some of the algos that are still active seek the next bid or offer to buy or sell.  The market response often triggers stop loss orders.

In the forex (foreign exchange market), there are usually billions worth of stop orders in the book at any given time.  When stop loss orders get hit, they become market orders, and this further exacerbates the illiquidity.

The French President began his speech in Paris on the evening of October 6/16 just after 8 am (Friday) – 7 pm ET Tokyo time.  He commented that Britain would pay the price for choosing the Brexit alternative.

Some saw the ensuing market swoon as a reaction to a fat finger trade, where a trader possibly entered a much larger sell order than wanted by mistake.

A fat finger error occurs when a trader places an order to buy or sell that is larger than originally conceived, for the wrong contract or stock, at the wrong price, or because of any number of input mistakes.  This can happen in either the foreign exchange market or the stock market.

Seven pm ET is one of the strategic forex time zones (see screen shot that follows).  It is when Wall Street goes home, and Tokyo takes over the book.  It can actually be closer to 8 pm ET.  There tends to be low liquidity during that handover period, which exacerbated the situation at hand in this case.

The forex (foreign exchange market) is the only market active at that time and, as such, that is where all computers are focussed until the equity markets open up again.

A note on forex time zones… if you are trading any of the six times in the screen shot below, the window of opportunity can include an hour or so on either side of each time.  Forex swing trading opportunities don’t usually occur exactly on the hours noted. 

Here are some examples of flash crashes in recent memory:

  1. May 6, 2010 – the most widely known and subject of the book Flash Boys by Michael Lewis;
  2. April 23, 2013 – the hacking of The Associated Press’s Twitter account, and headlines about the White House being attacked in hoax tweets;
  3. August 24, 2015 – the Dow Jones Industrial Average opening down 1,000 points, as a period of illiquidity was caused by anxiety over Chinese currency devaluation.

Regarding the infamous flash crash of May 6, 2010, the Dow plunged about nine percent, two-thirds of that over five minutes.  In about 20 minutes, almost all of the latter 600 points were regained.

Black swan events have precipitated other less well known episodes, which roiled the markets, and caused the computerized algos to behave erratically.

We haven’t seen the last of black swan events or flash crashes.  Nor will we be any better prepared to predict them.  Not even forex divergence – MACD divergence, MACD histogram divergence, or MACD inverted divergence – or even MACD will be able to forecast such occurrences.

Well, who could have guessed?  We just had a black swan event occur today (Friday, October 28/16), as I am writing this.  It was announced that the FBI are reopening their investigation into Hillary Clinton’s e-mail scandal.   The criminal investigation is back on.

The Dow dropped in a heartbeat.  Obviously, that could not have been foreseen.  I had just stopped looking at my stocks when the announcement was made, and was caught completely unawares.  

One thing you can do is to stop using stop loss orders to limit your losses, should your tradable go against you, say by 12%.  The same goes for buy orders.

If you think those measures are unreasonable, think back to 2009, when a computer entered orders on ETFs, which were 20-25% higher than market levels at the time.  This was caused by unfortunate events, which could happen again.

Trading was closed by the exchange and, when the market came back up, there were some pretty unhappy traders, who were filled much higher on their orders.

The answer is to use stop limit orders, whereby you specify the limit on the price your order will be exercised in the event of a meltdown.  This guarantees that you would have absolute control over any potential losses.

After price has reached a specified stop price, a stop limit order is executed.  When that happens, the stop limit order is turned into a limit order to buy or sell at the limit price or better.

On the buy side of things, you could set a limit price a few pennies above the prevailing bid.  That way, should the algos go haywire again, the fill would not go crazy on you.

With a buy limit order, you can specify the price you are willing to pay.  You are guaranteed to pay that price or better by using such an order.  This means that you will pay your specified price or less, and sleep well at night.

(Info via Larry Berman, co-founder of ETF Capital Management, and a regular on BNN – as reported in The Globe and Mail, October 11/16.)

Forex Time Zones

Picture of clock with 6 forex time zones to the left of it that represent forex swing trading points

Flash Crash 1 Hr. Chart

 

GBPUSD forex chart showing flash crash Oct. 6/16 at the Tokyo open

(Chart via ProRealTime.com)

Risk Management

“Years of torture that ends with the guillotine anyway is no better than the guillotine at dawn.”  (Eric Reguly, The Globe and Mail)

Translation:  Use 30-pip stops, and don’t be afraid to get stopped out.  It’s God’s way of kicking you to a higher plateau.  Don’t let price run away from you, if it goes against your trade.

Keep your losses small, and let your profits run.  And, don’t get out too soon.

You will learn a lot from getting stopped out.  When that happens, just jump up on your chair, and yell at the top of your lungs, “Next!”  Don’t get in a funk over it.  Just move on to the next trade, after you have digested what went wrong and why.  That’s the beauty of maintaining a trading log.  It keeps you honest with yourself.

TradingSmarts Wins Awards

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Quotes

“One man’s ceiling is another man’s floor.”  Bob Dylan

“Discipline is doing what you don’t want to do when you least want to do it.”

“Diversification is undesirable, once you achieve competency.”  John Maynard Keyes

“Be greedy when others are fearful, and fearful when others are greedy.”  Warren Buffett

“Believe none of what you hear, and only half of what you see.”  Benjamin Franklin

“This whole idea of an attention span is, I think, a misnomer.  People have an infinite attention span, if you are entertaining them.”  Jerry Seinfeld

“The ‘let me show you what I mean’ is one of the best ways to get your point across, when trying to explain something.”  Peep Laja

“Your advertising efforts ultimately boil down to the first five seconds.  In these crucial moments, consumers decide whether they’ll buy into your brand or check out completely.”  Joshua Conran (Inc.)

References

http://ca.investing.com/tools/forex-pip-calculator

http://www.investopedia.com/articles/forex/05/macddiverge.asp

http://www.investopedia.com/terms/b/buy-limit-order.asp

http://www.investopedia.com/terms/e/ecn-broker.asp

http://www.investopedia.com/terms/e/ema.asp

http://www.investopedia.com/terms/m/macd.asp

http://www.investopedia.com/terms/s/stop-limitorder.asp

http://www.pixabay.com

http://www.ProRealTime.com

http://www.theglobeandmail.com/

http://www.wealthandfinance-intl.com/

https://en.wikipedia.org/wiki/Fat-finger_error

https://en.wikipedia.org/wiki/MACD

https://en.wikipedia.org/wiki/Straight-through_processing

https://goo.gl/DBU3vW

https://goo.gl/rnO8k5

https://goo.gl/V2GnZd

https://www.tallinex.com/open-account?i=140383

Forex Tools

I understand that there is a MACD divergence indicator and a MACD divergence indicator mt4, but I don’t have experience with either.  I prefer the manual approach of identifying such divergence, because I look for three different forms of divergence on the fly – divergence proper, histogram divergence, and inverted divergence.  I don’t trust any indicator to do all that for me with any degree of certainty.  If you wish to comment, please do so in the comments section below or at the Contact link.

That said, a good support and resistance MT4 indicator can be had at the same contact link above.

If you’re interested in a pip value calculator, here’s one worth considering:  http://ca.investing.com/tools/forex-pip-calculator

You can also have the best pivot point calculator by dropping me a line at the Contact link.

At www.ProRealTime.com, they offer a number of forex trading indicators, including a forex support and resistance indicator for forex pivot points.

In my opinion, the best book on trendlines to analyze forex trends is Tom DeMark’s New Science of Technical Analysis.

Conclusion

There you have it my friend… MACD Divergence with MACD histogram divergence and MACD inverted divergence thrown in for good measure.  As you have seen in this presentation, all three forms of forex divergence will go a long way to bringing profitable forex trading your way.

If you are learning forex trading for the first time, and would like more free forex training, let me know at the Contact link.  One-on-one forex trading lessons can be arranged, and I can even be your forex mentor.

I also offer forex consulting, if that option appeals to you.  That can also be arranged at the same link.

Remember that forex money management, in the form of forex managed accounts, is available at Tallinex.

I hope you found this free forex training beneficial.  More forex trading lessons are in the pipeline.

There’s a whole lot more to learn from my previous blog posts:  VIX, After Hours Trading, Trading Volume, Stock Trading Stops, Currency Trading Strategy, How to Pick Stocks, Stock Trading Rules, Three Winning Stock Trading Strategies, Forex Trading Techniques, and Forex Pivot Points.

And, you can always learn more about me at the About link.

If you would like to help me start a forum and be a moderator, I would love to hear from you.  Just drop me a line using the Contact provision at the bottom of my site.

If you would like to be featured in my blog, I would love to share your success story – or even your trading experience.  Please send me a message using my Contact form at the bottom of this page.

I won’t live long enough to know it all, and I won’t live long enough to make all the mistakes myself.  So, hearing your story will be most helpful not only to me, but also for my other beloved readers.

Please share this post.  Sharing is caring.  Thank you!

I look forward to your articles, feedback, ideas, stories, and suggestions for my blog.  Please post these on my blog at the Contact link below.  

HAVE FUN and ENJOY LIFE!  Remember – FAMILY comes first!

Here’s To Your Success and Quality of Life,

prbain

Peter R. Bain
PS:  Don’t let them steal your dreams!
PPS:  I will help you achieve your dreams!

About Peter R. Bain

Picture of Peter R. Bain, founder of www.TradingSmarts.com – the go-to site for all things trading.

Peter R. Bain

I am a speaker, trader, writer, aviator, car nut, Harley enthusiast but, above all else, I am here for you at TradingSmarts, which I founded some 15 years ago.

TradingSmarts is your best friend when it comes to finding anything and everything to do with trading.  Through my blog you will always find guides, news, reviews, tutorials, and much, much more.

TradingSmarts is a ‘NO-BS, No-Holds-Barred, Take-No- Prisoners’ site for traders who want the straight-bill-of-goods on how to make a full-time income trading less than part-time. 

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