MACD Divergence Forex Trading Strategy

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MACD Divergence Forex Trading Strategy

When I was starting out learning forex trading, I heard a professional trader talk about his trading strategy on a podcast. He was talking about divergences and how this type of trading setup has made him very profitable.

Then, I read a book discussing a trading strategy revolving around divergences. He also included a link on the records of his live trading documentation. Looking at the history of his live trading, it showed that he had around almost 70% win rate and a reward-risk ratio at around 1:1. This might not sound much, but this is a very profitable trading strategy.

Divergences are one of the types of trading setups that professional profitable traders use. It has been tested and proven by professional traders. Back tests and forward tests that show a profitable long-term trading have been documented. This is enough proof that divergences do work.

Price movements oscillate back and forth on the price chart. These oscillations create peaks and troughs also known as price swings. Momentum could be identified based on the length of these short-term price swings.

Certain indicators, particularly oscillators, mimic these oscillations creating peaks and troughs in their own windows. It also mimics the momentum of a price swing based on the length of its own swings.

However, there are instances when the momentum indicated on the price chart and that on the oscillator would contradict. These are called divergences.

Divergences are indicative of a short-term trend reversal.

Below are the various types of divergences that traders look out for.

Divergence Cheat Sheet

MACD Divergence Forex Trading Strategy is one of the ways to trade divergences using a basic oscillating momentum indicator.

Zero Lag MACD

The Moving Average Convergence and Divergence (MACD) is a popular oscillating indicator. It is used to identify momentum, trend and overbought or oversold price conditions. Traders often use if for trend reversal and mean reversal strategies. Some traders also use it to identify trend and momentum.

The Zero Lag MACD is based on the classic MACD. The difference is that the Zero Lag MACD is modified to adjust for lag.

It is displayed using histogram bars and a line. Instead of using a Simple Moving Average (SMA) as the classic MACD does, the histogram bars of the Zero Lag MACD is based on the difference between a 12-period Exponential Moving Average (EMA) and a 24-period Exponential Moving Average (EMA). The Signal Line is also derived from the histogram bars as a 9-period Exponential Moving Average (EMA).

Trading Strategy

This trading strategy is a short-term trend reversal strategy based on the concept of divergences using the Zero Lag MACD.

To trade relatively high probability trade setups, we will be filtering trades based on the long-term trend. This would ensure that we are not going against the flow of the market. To identify the trend, we will be using the 200-period Exponential Moving Average (EMA). The long-term trend will be based on the slope of the 200 EMA as well as the location of price in relation to the 200 EMA line.

Then, we identify divergences using the patterns shown above. Trades are taken as soon as the MACD histogram bars and the Signal Line crossover during a divergence.

Indicators:

  • 200 EMA (Gold)
  • ZeroLag_MACD (default setting)

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

Currency Pairs: major and minor pairs

Trading Sessions: Tokyo, London and New York sessions

Buy Trade Setup

Entry

  • Price should be above the 200 EMA line.
  • The 200 EMA line should be sloping up.
  • The Zero Lag MACD and Signal Line should be below zero.
  • A bullish divergence should be clearly identified.
  • Enter a buy order as soon as the Zero Lag MACD histogram bars cross above the Signal Line.

Stop Loss

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

Exit

  • Close the trade as soon as the Zero Lag MACD histogram bars cross below the Signal Line.

MACD Divergence Forex Trading Strategy

MACD Divergence Forex Trading Strategy 2

Sell Trade Setup

Entry

  • Price should be below the 200 EMA line.
  • The 200 EMA line should be sloping down.
  • The Zero Lag MACD and Signal Line should be above zero.
  • A bearish divergence should be clearly identified.
  • Enter a sell order as soon as the Zero Lag MACD histogram bars cross below the Signal Line.

Stop Loss

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

Exit

  • Close the trade as soon as the Zero Lag MACD histogram bars cross above the Signal Line.

MACD Divergence Forex Trading Strategy 3

MACD Divergence Forex Trading Strategy 4

Conclusion

This short-term trend reversal strategy could be considered a high probability type of trading strategy. It aligns the long-term trend and the short-term trend reversal, has an element of overbought or oversold reversal, and is based on divergences. All these factors added up results in a sound trade setup that has a high chance of resulting in a profit.

Often, trading with the long-term trend using divergences is a hidden divergence pattern. Traders who could master identifying this type of divergence has a good chance of being successful with this strategy.

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