Could 2 MACDs Be Better Than 1?

DailyFX

Article Summary: The way into a trade isn’t always the best way out. Because trading is a zero-sum game, once you’re in a trade, the market (or your mind) will work to convince you that you should exit your trade, or that the market’s about to turn, or you should be happy with your gains thus far and call it a day. Often, this is not in your best interest. The MACD does a good job of showing you high-probability entries but a simple adjustment can help you ride the current move for what it’s worth.

Many traders work too hard on their entry and not spend very little time focusing on their exit. Unfortunately, it is your exit that will determine how much you ultimately take from the market or how much of your equity you give to the market testing out an idea. One tool that we can turn to fine tune our exits is the Moving Average Convergence-Divergence or MACD.

The MACD was created in the late 1970s by Gerald Appel who named MACD as an “indicator for all seasons”. Because the indicator can help traders’ time entry and exits as well as work on all time frames, it quickly became a favorite to many. However, a method was introduced by Appel in the creation of MACD to help traders stay in the right trade longer that we’ll explore in this article.

Learn Forex: MACD As Displayed Below Price Action

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Could_2_MACDs_Better_Than_1_body_Picture_1.png, Could 2 MACDs Be Better Than 1?

(Created using FXCM’s Marketscope 2.0 charts)

If you’re new to MACD, it is a rather simple product that is created by subtracting a longer-term Exponential Moving Average EMA from a shorter-term EMA to find trend direction. The red MACD line will rise if shorter-term trends are gaining strength and declines if shorter term trends are losing strength. The divisor on the picture above is known as the histogram or zero line and is the litmus test as to whether the trader is bullish or bearish in her outlook on the pair.

Signal Line for Trend Confirmation

The signal line helps you confirm whether the trend has the force or momentum necessary to carry it through. This confirmation is show when the MACD crosses above or below the signal line. On the chart above, the signal line (Blue) is a 9 period moving average of the MACD line.

Learn Forex: Signal Line & Histogram on MACD

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Could_2_MACDs_Better_Than_1_body_Picture_2.png, Could 2 MACDs Be Better Than 1?

(Created using FXCM’s Marketscope 2.0 charts)

Histogram – Filter for Trending Environments

The Histogram is your tipping point on the currency pair you’re considering to trade. When the shorter / faster moving average crosses the larger / slower moving average the MACD will cross the zero line in its respective direction. When the MACD is above the zero line, you should consider only entering buy trades or adding to an existing long position so that you’re not trading counter trend.

If you’re trading a histogram crossover, you’re essential trading a 12 & 26 moving average crossover. Moving average crosses are a tried and true trend trading system. However, the moving average cross isn’t always the best method to get you out of the trade that you entered so we will look at fine tuning the MACD to time our exit.

Traditional MACD Exits

The MACD methods that can be used to enter a trade can also be used to exit. In other words, you can look for a zero line crossover or the tradition signal of the MACD line crossing the signal line. However, as you can see from above, that will often have you in and out of trades while potentially losing out on the trade that you looked to capture in the first place.

Adding a Second Slower MACD Fore Exits

The argument for having two MACDs is that you have a sensitive (faster) MACD to get you into a potential trend and a less sensitive (slower) MACD for exits. As mentioned earlier, exiting a trade properly is often the toughest part of trading well and the second MACD can help with that. The settings we’ll use for the second MACD are 19,39,9.

Learn Forex: Improving Your MACD Signals with a Second MACD

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Could_2_MACDs_Better_Than_1_body_Picture_4.png, Could 2 MACDs Be Better Than 1?

(Created using FXCM’s Marketscope 2.0 charts)

The first thing you’ll notice is that each MACD has a specific purpose. The top MACD using the 12, 26, & 9 readings are used only to enter the trade. The bottom MACD using the 19, 39, & 9 readings are used only to exit the trade.

The entry rules are different from the exit rules so as to keep you trading into the direction trend but at the same time not to give up too much of your profits if it was a good trade. The entry rules look for a zero line crossover on the 12, 26, & 9. The exit rules look for a simple MACD line crossover of the signal line on the slower 19, 39, & 9.

The additional filter that can be used is a simple moving average on the chart like the 50, 100, or 200. The purpose of the simple moving average is to fine tune your entry even further so that if there is a buying zero line cross over on the entry MACD but price is below the simple moving average you trade with a caution. However, the goal remains the same of entering as soon as the trend shows itself and being slower on the exit so that you catch more of the trend.

Closing Thoughts

When markets breakout they tend to move very fast so you can use the same tool with different settings. Gerald Appel, the creator of MACD recommended using two MACD combinations so that you can buy fast and sell slow in an uptrend or sell fast and buy back slowly in a downtrend. When markets tend to be most erratic, the second MACD can help to calm your nerves and prevent letting go of hard fought winnings.

Happy Trading!

---Written by Tyler Yell, Trading Instructor

To contact Tyler, email tyell@fxcm.com.

To be added to Tyler’s e-mail distribution list, please click here.

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