Couple of weeks concept of MACD divergence was discussed here. I used daily chart CAD-JPY to illustrate the principles. Divergences can be traded with any of the oscillator type indicators. They are especially popular with Stochastic and RSI. One of the more important differences between MACD and these two indicators is their valuation. Both RSI and Stochastic always fall within certain set of values, between 1 and 100 and will not get above or below these levels. These limitations cause many “oversold” and “overbought” readings, creating huge number of divergences and increasing their failure rate. During prolonged price moves, they tend to be almost completely unreliable.

MACD doesn’t move within preset values. It can follow the price either up or down for much longer time, without being considered overbought or oversold. Divergences created with this indicator have a higher chance for probability, but happen less often than when employing other technical indicators. This doesn’t make Stochastic or RSI worse tools than MACD, only means that all of them should be used in different ways, exploiting particular aspects of each. When it comes to divergences, I find MACD more reliable.

This situation was spotted in Yen pairs. After a prolonged up move, daily charts built couple of tops, creating MACD divergences in the process. For time frame of such magnitude, this happens 2-3 times a year. Not very often, that’s why they tend to stand out and present decent opportunities. I chose bearish divergence of CAD-JPY. Here is the chart as posted at the time.

For all the details see original post, but I anticipated price to drop to about 85.00 or a little lower. For my own trade I chose to use the smallest possible stop as dictated by this chart- just above the high of the day that gave me the sell signal, or the highest point of this top. Small, chicken like stop. Out of character, because, normally, I don’t mind larger stops in relation to target. Unfortunately for me this stop was reached and my trade got stopped out. As soon as that happened, price fell again. Few days ago my original objective for the move, under 85, was achieved and this pair found support on 100SMA.

When the price made new high at point A, forcing me out of the first trade, MACD divergence was no longer very easy to see, but still existed. In situation like this, trading currencies, one should seek confirmation from another platform (software). Daily bars, or candles, often have different closing times, leading to somewhat varied reading between brokers for many indicators and their applications. That could be confusing, but in this situation was helpful.  There was little doubt when looking at the next chart.

As stated in original post, I was not looking for an all out market reversal, but rather a pull back. This doesn’t mean that a complete turn around could not happen. It only means that I wanted to catch the part of the move that has the highest probability of taking place. Now that this particular situation has played itself out, objective was reached, one should  conduct new analysis to determine if the price will continue lower, or resume its previous up trend. I’m more focused on smaller time frames  for now, as was shown in other posts about CAD-JPY trading.

In the end, the divergence lived up to expectations (this time). I was too timid and my original trade was stopped out, but had few smaller trades later in the direction dictated by this set up. Those more than recovered the first loss. There is no question, MACD divergences are useful and can be profitable, but like any other trading technique, one must devote some time to study examples and learn to identify them in real time. I’ll try to post another one in the future, when spotted.

Mike K.