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The MACD and the Moving Average

The MACD and the Moving Average

The_MACD_and_the_Moving_Average_body_78822d1298047459-trend-day-weekly-trading-lesson-218.png, The MACD and the Moving Average

We often hear traders talking about trading with the trend and that a classic buying opportunity is a pullback down to support in an uptrend and a classic selling opportunity as a rally up to resistance.

But how do we identify these two situations?

A couple of weeks ago in this column, we talked about the importance of the 200-day Simple Moving Average as a great tool to help identify the trend. If the market is moving up and above the moving average, the trend is up and we should look for buys. If the market is below the moving average and moving down, the trend is down and we should look for sells. This simple indicator can also be used on the intraday charts for this same purpose.

Today, I would like to add a second indicator to a chart...the MACD. This indicator measures the distance between two different moving averages. The 12-period and the 26-period are normally the default setting. We then add a 9-period moving average to that difference and we get the MACD. This tool was designed to help us better time our entry into a trade, so the key is to use it in a environment where it can offer more reliable signals.

This chart I have posted here is a 4-hour chart of the US30. This is the Dow Jones Industrial Average that many FXCM clients can trade as a CFD. But I am using it as it offers the ideal environment in which we can use two indicators as the beginning of a foundation of a trading approach. This market is moving up strongly and has been above the 200-period Simple Moving Average since it crossed up on December 1st of 2010. This is the environment where we want to buy pullbacks down to support. Or we can simply use the MACD crossover as the signal to enter into the trade. As soon as the candle closes, we check to see if the crossover happened. The key here is that the candle has to close to confirm the crossover and for buys, the crossover has to take place below the zero line. There are two examples on this chart. If that is the case, we simply buy at the open of the next candle and then place our stop below the low. For a target, we can use the 1:2 risk:reward ratio. If we risk 100 pips, we should look for 200 pips in potential profit. Of course for a sell, we would want to market to be trading below the 200-period Simple Moving Average and sell a crossover that takes place above the zero line