The double attack of moving average and MACD
Friends often ask me, which indicator is easy to use?
I myself have researched dozens of indicators and found that each has its own strengths and weaknesses; there is no absolutely perfect indicator. However, after trying them out, I have indeed found some indicators that are simple and easy to use, making them very beginner-friendly.
Moreover, I've discovered that by combining certain indicators, one can mitigate some of the inherent flaws of the individual indicators, amplify the advantages of the combination, and achieve better profitability outcomes.
So today, I will discuss in detail the moving average and MACD, the pros and cons of these two indicators, and how to combine them to avoid their shortcomings and complement each other's strengths.
You can also follow my train of thought and method to combine and match in the indicators you are familiar with, and you may achieve unexpected results.
1. The Moving Average and MACD Indicators
I believe that many of you who are engaged in trading have heard of these two indicators and are quite familiar with them.
The moving average is actually very easy to use.
It is simple and clear, easily visible on the chart, and can be added with a single click. The levels of the moving average are also very clear, requiring no subjective judgment, making execution very smooth.
The moving average is calculated by averaging the prices of the k-lines, with many parameters available, such as 10, 50, 100, 360, etc. For instance, the 10-day moving average is the average closing price of the previous 10 k-lines, the 50-day moving average is for 50 k-lines, and so on.Moving averages are quite versatile, capable of serving as a criterion for determining direction within a trading system, as well as standards for entry, stop-loss, and take-profit in trades. They can be applied across various markets and time frames.
There are numerous ways to use moving averages, but I most frequently employ two methods: using them as support and resistance levels, and utilizing golden and death crosses.
However, the drawbacks of moving averages are also quite evident.
(1) Moving averages are trend indicators and perform poorly in sideways markets, leading to frequent crossovers. Moving averages are derived from the closing prices of candlestick charts; if the prices of the candlesticks continue to rise, it will drive the moving averages upward. We often observe in trending markets that the price action relies on the support of the moving averages to rise consecutively, while in a downtrend, it relies on the resistance of the moving averages to fall consecutively. If the price of the candlesticks enters a consolidation phase, the moving averages will flatten or crossover repeatedly. At such times, using moving averages as a technical criterion for trading can result in a series of stop-losses. The chart shows a one-hour candlestick chart of gold, where for more than ten trading days, the market has been in a narrow range of consolidation, and the two moving averages have been crossing over frequently, leading to frequent stop-losses on the trading signals.
(2) When used as support and resistance, moving averages exhibit relatively poor stability. When employing moving averages as support and resistance levels, it is common to encounter situations where the market breaks through the moving average and then reverses, or where there is no reversal at all. If this criterion is used directly for trading, the success rate will be low, leading to a series of consecutive stop-losses.Moreover, trading directly without a particularly reasonable stop-loss position can be used, and without a reasonable stop-loss, it will also affect the setting of position size and profit-taking targets. Therefore, when using moving averages as support and resistance for trading, it is best to incorporate other technical criteria for filtering. The chart shows a 1-hour candlestick chart of the Euro to US Dollar, where the 60-period moving average is used as a support and resistance level. If traded directly, the success rate is not high, and there are also many consecutive losses.
The MACD indicator also has many advantages. The MACD indicator, also known as the Moving Average Convergence Divergence, can be directly added to the chart. The MACD indicator typically consists of two lines, one bar, and an axis on the chart. The two lines refer to two moving averages, one is a fast line, and the other is a slow line. The bar represents the energy column on the chart. The axis is the zero-axis in the middle of the MACD chart. When the energy column is below the zero axis, it indicates a bearish trend, and when the energy column is above the zero axis, it indicates a bullish trend.
There are mainly two ways to use the MACD: one is the golden cross and death cross of the fast and slow lines, and the other is the divergence between the energy column and the candlestick pattern's tops and bottoms.The standards for MACD are also very clear, and it can explicitly signal the arrival of tops and bottoms on the chart.
Moreover, the dual lines of MACD on the chart are more conservative, which can filter out the frequent crossovers of moving averages, addressing the issue of generating false buy and sell signals. Therefore, using these two indicators in combination can produce very good results.
Like moving averages, MACD can also be applied to different markets and various time frames.
MACD also has its drawbacks.
(1) Overbought and oversold dullness, leading to consecutive stop losses.
In some consolidating downtrend markets, MACD may remain in an overbought or oversold state for an extended period. If trading is based solely on the logic of overbought and oversold conditions, consecutive stop losses will occur.
The chart shows the 4-hour candlestick chart of the Euro against the US Dollar. When the candlestick dropped to 1.08900, the MACD histogram had already touched the bottom. However, in the subsequent consolidating downtrend, the candlestick slowly set new lows one after another, but the histogram continued to contract upward, remaining in an oversold state for a long time. If executed without filtering and executed simply, consecutive stop losses will occur.
(2) Overbought and oversold is a zone, and it is not easy to choose an entry position.
As a standard for judging market reversals, MACD usually marks an area rather than an exact point. If other indicators or standards are not used in conjunction with trading, it is difficult to find an accurate entry point, which is not conducive to setting stop losses and take profits.
The chart shows the 1-hour candlestick chart of the Euro against the US Dollar. When the market rose to the position of 1.06200, it gradually formed an overbought condition in MACD (the red circular position in the chart). At this time, it is only known that the market has an expectation of reversal and has entered a price range that may reverse, but it is not possible to find an accurate opening position through MACD.As the saying goes, every measure has its advantages and disadvantages, and it is normal for each indicator to have its own strengths and weaknesses. What we need to do is to find some complementary indicators, to play to their strengths and avoid their weaknesses, in order to achieve better trading results.
2. Combination Usage of Moving Averages and MACD
Next, I will explain two combinations of moving averages and MACD, and you can also draw inferences from one instance to find more indicator combinations to discuss together.
The first method: Use the moving average as a support and resistance level, and trade in conjunction with MACD.
This approach can address the second disadvantage of the moving average mentioned above, which is the low success rate of support and resistance.
When the large-scale K-line tests the moving average, switch to a smaller scale. If a divergence pattern appears in the MACD at the smaller scale, combine it with the breakdown of the smaller-scale K-line pattern to enter the market, and set a profit-to-loss ratio of more than 3:1 to exit.
We will use the 4-hour chart in conjunction with the 15-minute chart as an example for explanation.
When the 4-hour scale, the market tests the moving average from top to bottom + 15-minute MACD bottom divergence, enter the trade.
When the 4-hour scale, the market tests the moving average from bottom to top + 15-minute MACD top divergence, enter the trade.
The chart shows the K-line chart of the euro against the US dollar, with the left side being the 4-hour scale and the right side being the 15-minute scale.After the market tests the moving average from below and moves upward, there is an expectation for the market to reverse and move downward, at which point the candlestick chart should be switched to the 15-minute chart on the right.
The 15-minute market unfolds a weak consolidation trend at the top, and at this time, the MACD also shows a top divergence, indicating an expectation for a decline in the 15-minute chart.
Wait until the 15-minute chart forms a top consolidation breakdown, and enter a short position when it breaks below the trendline, setting the stop loss above the high point. Subsequently, the market falls significantly.
Notes:
(1) Coordinating with the 15-minute MACD can effectively solve the technical issue of stop-loss placement, with a small stop-loss space and a large reward-to-risk ratio. Friends who like to trade trends can also change the exit method to increase the reward-to-risk ratio, or even use a larger time frame trend exit for trend-based trading.
(2) Other combinations of different time frames are also feasible, such as the 1-hour and 5-minute charts, with the same trading logic.
(3) It is common for larger time frames to break through the moving average. This situation does not affect trading. After the market stabilizes, wait for the MACD divergence and breakdown patterns to appear again at a smaller time frame before entering the market.
The second method: After the MACD shows divergence, use the moving average crossover as the entry signal.
This plan can address the first disadvantage of MACD mentioned above: the oversold/overbought dullness, leading to consecutive stop losses.
When a MACD divergence is identified on the chart, there is an expectation for a reversal in the market. Wait for the moving averages on the chart to show a crossover in the opposite direction before entering the position.Let's take 4 hours as an example for explanation.
When a 4-hour chart shows a top divergence combined with a moving average death cross, enter a short position.
When a 4-hour chart shows a bottom divergence combined with a moving average golden cross, enter a long position.
The chart is a 4-hour candlestick chart of the Euro against the US Dollar. The market has been continuously rising from 1.07800 to 1.11300, showing a long-term MACD top divergence and dullness.
During the dullness, the two moving averages, EMA30 and EMA15, did not form a crossing entry signal until the market rallied and then fell back, forming a death cross of the moving averages.
After the death cross, enter a short position, and the stop loss can be set at the inflection point above, with a risk-reward ratio of more than 3:1.
Notes:
(1) The two moving averages avoid continuous stop losses in the dullness range, improving stability and success rate.
(2) This method is also feasible in other time frames, such as 1 hour, 15 minutes, or even larger daily levels.
(3) Exiting can be a fixed risk-reward ratio, or you can directly use the two moving averages to track the trend for profit-taking, making trend-based trades.Today, the ideas and methods I share with you are merely intended to inspire, to show you that indicators can be used in combination to achieve better results.
You can also select a few indicators from those you are familiar with that can complement each other's strengths and try to combine them. However, before applying any combination in real trading, you must conduct extensive backtesting and simulation testing on your own, and do not use them directly without due consideration.
I wish you all the best in finding indicators that suit you.