Introduction to MACD Divergence

The MACD indicator has always been one of the most widely used technical indicators because it tends to follow the trend and the general price movement of a particular market very well, and can be very effective at indicating a change of trend when the two lines cross.

Furthermore, when you combine the MACD indicator with the MACD histogram, you can get some very powerful signals on occasions.

One of the most powerful signals is when the price of a particular market is making new highs, or is making two or more peaks at the end of an upward trend, for example, but both the MACD and the MACD histogram are failing to make new highs.

This will often indicate that the trend is running out of momentum, and it might be worth opening a short position on any big downward price move or any real sign of a reversal.

Real Life Example on the EUR/CHF Pair

If you take a look at the daily price chart of the EUR/CHF pair below, you will see that we had a classic MACD divergence pattern on this particular pair in April and May:

The three arrows on the chart indicate the peaks at the top of the upward price trend, and you can see that on each peak both the MACD and the MACD histogram failed to make new highs.

Therefore when the price failed to make another new high and actually moved strongly below the 200-day exponential moving average (indicated by the red line), this would have been a good opportunity to open a short position.

As I always say, you always want to be trading when the odds are firmly in your favour, and when you get a strong MACD divergence pattern like this one, this is a good example of a high probability trade.

If you had entered a short position on the closing breakout candle at around 1.1290, you could have made up to 170 points before there was a reversal.

A Word of Caution

I want to finish by saying that you sometimes need to be careful when looking for divergence patterns, and should only look for the very best set-ups.

Staying with the EUR/CHF pair, the price continued moving downwards, and you can see that there was divergence on the MACD histogram once again, indicating that the new downward trend may have been running out of momentum, but the MACD indicator continued to make new lows, so this would have been a more risky trade.

Indeed you would actually have lost money if you had gone long on the MACD histogram divergence alone, which is why it is better to wait for divergence on both the MACD indicator and MACD histogram when trading forex pairs or any other markets.