The MACD Forex Trade Example

03/10/2010 12:01 am EST

Focus: FOREX

The important first step in identifying a potential trading opportunity is to pick the right pair. What we should be looking for is strong-trending markets, and then, we must find a trade in that same direction.

Taking advantage of the momentum of the market increases our chances of success on the trade and allows us to look for more potential profit when we are right than we are willing to risk on the trade.

This daily chart of the GBP/USD shows a nice trending move to the down side. This is noted by the lower highs and lower lows on the chart. Downtrends will look like stair steps moving down, while uptrends look like stair steps moving up. The steeper the stairs, the stronger the trending move.

chart
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In a downtrend such as this one, we want to look for a rally up to resistance to sell. At this point in time, we can see where the market is moving up off of a low.  Now is a good time to move down to the four-hour chart to get a closer look at this move and a way to time our sell entry. 

chart
Click to Enlarge

This chart shows a closer look at that move up off of the March 1 low. Also on this chart, we have MACD plotted. The MACD, which stands for the Moving Average Convergence Divergence, shows the difference between the 12-period moving average and the 26-period moving average. That difference is noted by the red line on the chart. The blue line is referred to as the signal line and is a nine-period moving average of the MACD line. 

The main purpose of the signal line is to signal the sell entry into this trade.  When the MACD line (red) crosses down through the signal line (blue), that is the signal to sell. An important key is to wait until that candle closes so we can confirm the crossover actually took place. We would not want to sell on a crossover in the middle of a four-hour candle only to see the market reverse and negate the crossover. 

So the sell would be at the open of the next candle after the crossover. We could then place our protective buy stop above the recent high and look for twice that risk in potential profit for our 1:2 risk/reward ratio

By Thomas Long of DailyFX.com

DailyFX provides forex news on the economic reports and political events that influence the currency market.

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