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MACD Divergence Forex Signal - How Reliable?

Some traders regard MACD divergence as a Forex signal to enter a high probability trade. They almost suggest you get straight in to a trade as soon as you see MACD divergence.

Is this Forex signal that reliable? To be fair, it certainly has a place in a successful trader's kit of strategies, but as with any Forex signal, there are certain precautions that have to be observed to make any trade high probability.

At this time there doesn't appear to be any Forex signal that offers anywhere near a 100% success rate.

So if you are tempted to trade on the basis of MACD divergence, what other factors should you keep in mind?

MACD Divergence Defined

First let's just spell out exactly what is meant by MACD divergence.

MACD (Moving Average Convergence Divergence) comes as a standard Forex signal on all the main charting packages. Some show MACD by itself with two lines, one a combination of a 12 and 26 Exponential Moving Average, and the other line based on a 9 Exponential Moving Average.

Some charting packages also include what is called a Histogram in the same charting area as MACD. The histogram merely represents in a different way what is happening between the two MACD lines as to market momentum. The wider the gap between the MACD lines, the higher or lower the height of the histogram bars.

To identify MACD divergence, simply draw a line across the highs if MACD is above the zero line, or draw a line across the lows if MACD is below the zero line.

Now go to the price action section of the chart, the candlesticks, and draw a line across the highs directly above where the line is drawn on the MACD highs, or draw a line across price lows directly above where the line is drawn on MACD lows.

If they are going in opposite directions you have MACD divergence. In other words, when MACD is making lower highs and lower lows but price is making higher highs and higher lows, this negative MACD divergence forms a Forex signal indicating price could well start to drop.

If MACD is making higher highs and higher lows but price is making lower highs and lower lows, this positive MACD divergence forms a Forex signal indicating price could well start to rise.

MACD Divergence Precautions

Be aware that MACD divergence on a smaller time frame is not so significant. When it is seen on a 15 minute chart it may or may not be very important.

If seen on a 60 minute, 4 hour, or daily chart, start doing more analysis.

If you see MACD divergence on two or more of the higher time frames, then definitely sit up and take notice and start looking for other factors to indicate when price may react to the divergence.

This brings us to a key point when trading MACD divergence as a Forex signal to enter a trade. On a higher time frame, MACD divergence can be a fairly reliable indicator of a change in price direction. However, the big question is: WHEN?

Many traders get caught out by entering a trade too soon when they see MACD divergence. In many cases, price has still got some muscle to continue in the current direction. The trader who has jumped in too soon can only stare at the screen in dismay as price shoots through his stop taking him out.

How Can This Scenario Be Avoided

Before pulling the trigger when you see MACD divergence on the higher time frames, be sure to look for other key Forex signals to confirm that the divergence has really kicked in.

For example, if you see a distinctive candle pattern such as a tweezer top or a hanging man on the higher time frame it may appear price has topped out and is now ready to move in the other direction.

If at the same time the distinctive candle pattern is at a key level of previous support or resistance, or at a pivot level, or a Fibonacci retracement or extension level, you have added reason to believe this could well be a turning point and put an entry order in at this level to get taken in.

At the same time, you will want to consult your trading calendar to make sure you are not entering a trade near a significant Fundamental Announcement. Even though the MACD divergence may kick in soon, the Fundamental Announcement could cause a major spike in price and take out your stop.

So in summary, is MACD divergence a high probability Forex signal?

Answer: By itself NO!

How can MACD divergence be used safely?

Answer: Check to see if MACD divergence is seen on one or more higher time frame charts such as the 60 minute, 4 hour, or daily.

Then look for other Forex signals such as candle patterns, support or resistance levels, or Fibonacci retracement extension levels.

In other words, use MACD divergence as a confirmation Forex signal that you are going in the right direction rather than a stand-alone Forex signal.

Michael A. Jones is a writer, webmaster and Forex trader.

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Online FOREX Trading - Fundamental v Technical Analysis Which Is Best?

When you trade online FOREX markets you have a choice of using charts (technical analysis) or studying the fundamentals and news stories (fundamental analysis) but which is best?

Here we will compare the two and tell you which is best for online FOREX Trading.

1. Fundamental Analysis.

The fundamental trader will look at the supply and demand situation and try and determine which way prices are going by studying and acting upon the facts.

Of course, any currency will respond to the fundamentals, but trying to trade off news stories and the facts presents a problem.

The problem is:

Prices don?t move logically and they don?t respond to the facts alone.

A simple equation will make this clearer:

Market Fundamentals + Investor Perception = Price movement.

We all see the facts, but we make our own judgments on them.

Millions of traders do this and they ultimately as a whole determine the price.

Fundamental analysis is very difficult for a trader to do, because the facts are in our world of instant communications are discounted immediately.

The market therefore moves very much on how traders view the outlook for a currency and they look towards the future.

Consider this fact

If it were easy to trade knowing the fundamentals and listening to the news, a lot more traders would make money and the fact is they don?t.

Today the information we get in online FOREX trading is more comprehensive and is delivered quicker than ever but just as 100 years ago, the ratio of winners to losers remains the same 90% lose, 10% win.

2. Technical analysis

If you have read and understood the above, you will see that technical analysis takes into account the fundamentals as the facts immediately are discounted and show up in price action .

The big advantage of technical analysis however is it does something more:

It shows how investors perceive the fundamental supply and demand position.

As human psychology has remained constant over time, it shows up in repetitive price patterns and these can be traded for profit.

Technical analysis is a better way to trade FOREX as it shows us the whole picture:

The fundamentals and more importantly, how they are perceived by the investors.

A word of caution

Technical analysis is an art and not a science.

Its limitation is that:

Humans are not predictable all the time, so there is no sure fire way to make money on every trade.

But just like a footballer who kicks penalties, knows his skill can help him hit the target the majority of the time, so to does a good chartist.

He may not win all the time but he trades with the odds and will win more than he losses.

Which is best?

As you can gather we think technical analysis is the best way to trade online FOREX.

It consumes less time, gets the odds in your favor and gives you the overall picture, taking into account both the supply and demand situation as well as investor psychology.

The fundamentals are important, but so to is how investors perceive them and this is why technical analysis is such a powerful way to seek big profits in online FOREX trading.

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Forex Information - How To Draw DeMark Trendlines

When searching for Forex information on the internet you are likely to find articles relating to trendlines and trendline analysis.

Tom DeMark is a specialist in the field of technical market analysis and his best-selling book "The New Science of Technical Analysis" released in 1994 spells out some innovative techniques when it comes to the use of trendlines.

Much Forex information on the internet is of a general nature, and many articles are written about Forex by individuals who are not traders themselves. Tom DeMark on the other hand has had a long career with institutions trading stocks, futures, currencies and options.

His guidelines on the use of trendlines are very specific and they can be helpful to the newer trader who is searching for reliable Forex information on how to use standard indicators.

Here is a brief step-by-step description of how to draw DeMark trendlines:

Note: The term swing high and swing low (also called cycle high and cycle low) refers to the following:

In An Uptrend: A swing high is the wick of a candle that is higher than the wick of the candle to the left and right.

In A Downtrend: A swing low is the wick of a candle that is lower than the wick of the candle to the left and right.

Obviously the more candles to the left and right that are higher in a swing low or lower in a swing high makes the swing or cycle more significant.

An uptrend is where price is making higher highs and higher lows. A downtrend is where price is making lower highs and lower lows.

Drawing DeMark Trendlines

Drawing Trendlines In An Uptrend

Examine the bottoms of the candles on your chart and identify the most recent candle wick that is lower than the candle wicks to the immediate right and left of it.

Look left on the chart, and identify the previous low candle that has candle wicks higher to the immediate right and left of it which is lower than the current low candle.

Now draw a line from the current lowest candle to the previous lowest candle (drawing from right to left).

Now take the end of the newly drawn line which stops at the current low candle and extend it forward some distance (drawing from the present position to the right).

Drawing Trendlines In A Downtrend

Examine the tops of the candles on your chart and identify the most recent candle wick that is higher than the candle wicks to the immediate right and left of it.

Look left on the chart, and identify the previous high candle that has candle wicks lower to the immediate right and left of it which is higher than the current high candle.

Now draw a line from the current highest candle to the previous highest candle (drawing from right to left).

Now take the end of the newly drawn line which stops at the current high candle and extend it forward some distance (drawing from the present position to the right).

You have now drawn a Tom DeMark trendline.

This can now be a reference point for future price action. It will often be observed that price will come and check this level. If it breaks through, it can mean a change in direction, the significance of which will depend on the time frame being used.

Trendlines drawn on 5 minute or 15 minute charts have much lesser significance than trendlines drawn on higher time frames such as the 1 hour, 4 hour, or daily.

Caution Required

Much Forex information extols the virtues of trendlines as an indicator of possible future price action.

Mr. DeMark certainly has made this a science and his detailed approach to drawing trendlines is certainly more accurate than just drawing general trendlines along the bottoms and tops of trends according to the way the eye sees.

However, trendlines in themselves do not indicate where high probability trades can be taken.

It is important to use a variety of indicators before pulling the trigger. Examining previous levels of support and resistance is probably far more significant in determining where price is likely to hesitate that watching trendlines.

However, they can be useful. If you find a key support or resistance level also coincides with a Fibonacci retracement or extension level which is also at an intersection with a trendline, then you have built a reasonably solid case for a trade.