The Value of Indicators: MACD, RSI and the Stochastic Oscillator

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Welcome back traders!

One of the main components of technical analysis is the use of oscillators while trading your favourite instruments.

In fact, Valutrades has posted a full webinar on this topic and it can be found on the Valutrades website under Education, On-Demand Webinars, and How to Spot Setups and Trade Currency Using RSI, MACD and Stochastic Oscillator.

So, let’s take a quick look at these three powerful tools.

On your MT4 platform, under Oscillators, you will find MACD which means “Moving Average Convergence Divergence”.

The MT4 version of MACD consists of a Histogram which is created by plotting the difference between the 12-period Exponential Moving Average against the 26-period Exponential Moving Average.

It also includes a Signal Line which represents the 9-period Simple Moving Average.

These two are plotted under or over a “Zero” level and can indicate either overbought or oversold.

The MACD is a trend following indicator so let’s take a look at using this oscillator to trade in an uptrend.

Remember, “The Trend is Your Friend” so we only want to look at “Buy” trades on this chart.

The first option is to find “Long” opportunities where the histogram crossed from oversold to overbought.

We can see that this would have worked in every case.

The next is to use the histogram to spot extremes of overbought or oversold to indicate a possible reversal of the current trend.

The most popular method of using the MACD indicator is to wait until the Signal Line crosses out of the histogram as a confirmation of the change in direction of price action.

This gets us into a trade sooner and safer than the other two methods and you can easily backtest this on any time frame and any symbol.

The Relative Strength Index (RSI) can also be found under Oscillators and a line chart displays the average number of positive price changes vs the average number of negative price changes, and plots this between 0 and 100.

Here we see a ranging market where anything in the region or above 70 indicated an overbought situation and that a reversal to the downside might be imminent, and on the other side, oversold situations where a reversal to the upside may be coming.

In trending markets, we can see that the RSI maintained its reading on one side of the middle, between 50 and 100 in an uptrend, but dipped lower and reversed, to indicate a continuation of the trend and an opportunity to buy into the upward momentum of this symbol.

The Stochastic Oscillator is another popular oscillator which consists of 2 moving averages which plot the rate of change in price.

The theory is that before price action changes direction, momentum will slow down.

The proof is in the backtesting.

We can see in this ranging market that the Stochastic Oscillator perfectly picked the points of reversal and in trending markets, we can use the indicator to show us when the trend is likely to continue.

Like RSI, the Stochastic Oscillator is plotted between 0 and 100 with 80 being overbought and 20 being oversold.

Also, we can use divergences and patterns with the movement to indicate strong trends like this.

As with any oscillator, you should use these in combination with other indicators and strategies as confirmation to enter and exit positions.

That’s all for now.  Happy trading with Valutrades and we will see you soon.
 
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