What is MACD Divergence?

In my opinion, one of the strongest signals generated by technical indicators is MACD divergence on a daily chart. MACD stands for Moving Average Convergence/Divergence and can be quite useful for giving hints of a possible market reversal.

We calculate this indicator by generating a 12 period Exponential Moving Average and a 26 period Exponential Moving Average and plotting the difference on our chart. We then add a 9 period Exponential Moving Average of that figure and plot that as our Signal Line. We now look for two situations. Positive Divergence is when the MACD makes a higher low but the market makes a lower low. This situation gives us a hint of a possible reversal to the upside. The other situation is Negative Divergence and is noted when the MACD makes a lower high while the market makes a higher high. This situation gives us a hint of a possible reversal to the downside.

Since I am a trend trader and only trade in the direction of the daily trend, I would not look to initiate is new buy position when noting Positive Divergence or a new sell position when noting Negative Divergence. However, if I were already in a trade and the MACD showed a possible reversal, I would tighten up my protective stop by moving it closer to the current market price to protect any profits that I may have in the trade at that time. As with any technical indicator, the best signals will come on the daily chart and as the time frame shortens, the reliability of the signal weakens.

Thomas Long, FX PowerCourse Instructor
FXCM