Technical indicators such as moving averages, Bollinger Bands and stochastics can help a trader of Forex, stocks or futures in a variety of ways. They can confirm trends, point to buy and sell opportunities or contradict other indicators. Confirmation by two or more indicators presents a stronger case for making a trading decision than relying on just one. The Moving Average Convergence Divergence, or MACD, and Relative Strength Index, or RSI, are two popular indicators that can be used together. These indicators will often have default settings on your trading platform, but you can alter time frames according to your preferences.
Use MACD histograms only when the market is trending. You could use the indicator in ranging markets, but you would need additional confirmations elsewhere. Three components to the MACD technical indicator exist: the MACD line, which plots the difference between two exponential moving averages; the signal line, or the moving average of the difference of these averages; and the MACD histogram. Traders use the MACD line and signal line to observe changes in their relative behavior and determine the existence of a trend; however, because this can be slow-going, the MACD histogram comes in to plot the distance between these two lines. The histograms appear as a series of undulating bars underneath and in tandem to these lines. When MACD is above the signal line, the histogram will be positive, or above the histogram's zero line. This would denote an uptrend. Inversely, if MACD is below the signal line, the histogram will be negative, or below the zero line, and indicate a downtrend. The highest point of a histogram will be the greatest gap between the MACD and signal lines. The histogram will be at zero when the two lines cross, and in fact it can return to zero well in advance of their crossing.
Have RSI alert you to overbought and oversold conditions. The RSI is a momentum oscillator that compares upward movements in closing price to downward movements over a given number of days, usually 7 to 9 days, but 14 days and 21 or 25 days are also used. This indicator fluctuates between 0 and 100, notifying a trader as to overbought and oversold conditions. Depending on whether you are trading a trending or ranging market, RSI's parameters will vary. Because you are using MACD histograms for trending markets, an RSI of 40 would indicate oversold conditions whereas an RSI of 60 points to overbought ones.
Go long (buy) or short (sell) based on specified conditions of MACD and RSI in your trading plan. In both cases, only trade in the direction of the trend. For example, go long when the MACD histogram turns up below zero; go short when the histogram goes down above zero. You may or may not choose to seek confirmation elsewhere. However, it might help to see a pullback in the trend where the risk of entering a trade will be lower. In this case, go long in an uptrend when RSI falls below 40 and rises back above it; go short in a downtrend when RSI rises above 60 and falls back below it.
Use one aspect of MACD to confirm another in buy or sell decisions. A negative MACD histogram can confirm a bearish MACD line to thus establish a downtrend and vice versa. Greater confidence in the trend can result in more focused trading, since an established bullish trend will naturally call for opportunities to go long or short in bearish trends.
Take profits using RSI. If you are holding a long position and RSI rises to 80 or more, take some profit to avoid losing accumulated profit. Or in a short position, take profit when RSI dips to 20 or below.
Timothea Xi has been writing business and finance articles since 2013. She has worked as an alternative investment adviser in Miami, specializing in managed futures. Xi has also worked as a stockbroker in New York City.