The strategy to be described in today’s article is the MACD histogram strategy, which can be used for exotic currency pairs such as the USDRUB, USDTRY, USDZAR, as well as the various pairings of the major currencies with the Norwegian and Swedish Crowns (NOK and SEK).
Indicators
The MACD Histogram we shall use today is a customized indicator which has the MACD histogram bars, as well as the fast and slow moving average lines. The MACD Histogram has been coded with an ability to detect divergences as well as moving average cross signals within the indicator, which can then be applied on the charts. These signals are automatically placed by the indicator once the setups have been spotted. Therefore, all you need to do is to place the indicator on the selected currency pairs, and allow it to deliver the signals to you.
The indicator is available as a free download from the MQL5 Community website.
Currency Pair Selection
The use of exotic currency pairs here is deliberate. They are illiquid pairs which are not usually affected by many of the common news events that get released daily. Furthermore, they tend to have very large moves and so can lead to some bankable moves when using this indicator. So the exotic pairs mentioned could make for some very decent moves if the strategy calls are caught early.
Strategy Description
How does the strategy work?
The Divergence
The MACD indicator is an oscillator, but tends to give slow signals which end up being too late to work with when they occur. So the use of a moving average crossover within the MACD indicator could help balance this out. This is why one signal is to use the divergence of the blue line from the price candles. A divergence in this case is as follows:
- A) Price is showing lower lows while the indicator’s blue line is showing higher lows. Lines are drawn by the indicator to showcase the divergence. In this case, the divergence is expected to correct by price eventually heading upwards to correct this divergence.
- B) Price is showing higher highs when the MACD histogram’s blue line is showing lower highs. Here, the divergence will correct when price eventually follows the indicator’s signal by moving lower. The MACD histogram will automatically draw lines to show the divergence.
This is the way the indicator works. Usually the indicator will point an arrow in the trade direction: a green arrow for a long trade and a red arrow for a short trade.
The Filters
There will also be occasions that the indicator will need two or three tries to get a signal. These are the occasions where you need to filter the signals to ensure you have the right setup going.
- A) You can also add a filter by ensuring that the first peak in the lower highs, or the first trough of the MACD histogram used in checking for the divergence signal is way into overbought and oversold territory on the indicator window respectively. This increases the chances of not having a fakeout.
- B) Check the price level: is there a major support or resistance that you can reference the present price position on? The closer price is to a previous resistance (for negative divergence and a short trade), or to a previous support (positive divergence and a long trade), the better the chances of success.
- C) More importantly, if the blue line crosses the red line before each lower high or higher low that the MACD histogram makes, this increases the chances of success.
Now that the rules are in place, let is look at the trade scenarios.
Short Trade
The short trade setup is as follows:
- A) Price is showing higher highs and the MACD histogram is showing lower highs.
- B) The indicator will trace the relevant lines and point a red arrow in the trade direction, which is down.
- C) Confirm the trade by checking to see if the price is at a previous resistance, or close to it.
- D) Confirm that the first peak of the MACD histogram forming the lower high is at a greatly overbought level.
- E) Check that the blue line has crossed the red line in the MACD histogram window.
- F) If these three filters are in place, execute the short trade.
- G) Set the stop loss above the high price of the previous resistance and use the next support as the initial profit target. Use a risk-reward ratio that is at least 1:3.
Here is the chart snapshot showing this setup as well as the application of the various filters in place.
MACD Histogram Divergence: Sell Setup
Here, we can see that the blue line of the MACD histogram crossed the red line of the histogram before each peak occurred. The price was showing higher highs while the lower lows of the indicator was well overbought. Similarly, the price setup occurred at a previous resistance area. We also see that there was a well-defined previous support, which helped secure the Take Profit area.
The presence of a previous resistance on which the Sell entry was anchored, as well as a previous support for the trade exit, provided a good way to gauge the 1:3 risk-reward ratio, providing the needed balance to gauge profitability.
We also see a second setup which did not meet all the filtering criteria, and as we can see from subsequent price action, that setup did not do well.
Long Trade
The long trade setup is as follows:
- A) Price is showing lower lows and the MACD histogram is showing higher lows.
- B) The indicator will trace the relevant lines and point a green arrow in the trade direction, which is up.
- C) Confirm the trade by checking to see if the price is at a previous support, or close to it.
- D) Confirm that the first trough of the MACD histogram forming the higher low is at a greatly oversold level.
- E) Check that the blue line has crossed the red line in the MACD histogram window before each low.
- F) If these three filters are in place, execute the long trade at the open of the next candle.
- G) Set the stop loss below the low price of the previous support and use the next resistance as the initial profit target. Use a risk-reward ratio that is at least 1:3.
Here is the chart snapshot showing this setup as well as the application of the various filters in place.
MACD Histogram Divergence Strategy: Buy Setup
Here, we can see two setups that met all the criteria and turned out well, and one that did not meet the filters and which did not end up well. The failed signal showed a situation where the MACD’s blue line failed to complete the second cross in good time, which negated the signal.
The first two worked out well with previous support areas to anchor the long entries. The blue line crossed the red line before each trough and all in oversold areas.
Closing Note
Practice this strategy and learn to identify the filters and use them before any trades are made.