Both the moving average convergence divergence (MACD) and the relative strength index (RSI) rank among the most popular momentum indicators used in forex trading. When used in combination with other technical indicators, both MACD and RSI can offer value in validating trade opportunities and timing trades to optimize your risk management practices.
While they represent a similar approach to evaluating forex trades, the functions of both MACD and RSI are distinct, which makes them useful indicators to combine in trade evaluation. Here’s a look at how to use MACD and RSI as part of your trade analysis.
The Basics of MACD and RSI
MACD histograms offer an easy visual representation of both the strength of a forex price trend as well as signals that may indicate a change in momentum. On the CHF/JPY chart below, the gaps between the 26-day EMA (the blue line) and the signal line (the red line) correlate to the momentum of the price movement. The larger the gap between these lines, the stronger the trend in either direction.
When those lines converge and then cross over one another, it can indicate a shift in momentum that traders may use to time their exit from a position or to plan a new position that aims to capitalize on this opportunity. In the CHF chart below, two such crossovers coincide with changes in price movement for the currency pair.
While RSI also measures momentum, it reflects this momentum through a different analytic approach. RSI can identify buying opportunities by pinpointing trade opportunities where conditions of a currency pair are either overbought or oversold. In situations where conditions are overbought, RSI suggests that the price may be inflated and primed to decline.
In oversold conditions, RSI suggests that traders may have overreacted and have now created value by depressing price and demand for a currency pair. The functionality of RSI is evident in the GBP/USD chart below, where a dive into oversold conditions—below the purple range on the RSI graph—leads to a quick price increase for the currency pair.
Because these momentum indicators evaluate trade opportunities through different methods, they can work well together in validating the signals each one provides, giving traders more confidence when both indicators agree on a potential buy opportunity.
Best Practices for Using MACD and RSI Together
As you incorporate MACD and RSI into your trading strategy, you will likely identify your own set of preferences when it comes to when and how you apply these indicators to your trade analysis. In general, though, you can maximize the value of MACD and RSI through the following best practices:
Combine MACD and RSI to Confirm Price Momentum
The simplest application of these indicators can offer a lot of insight and clarity when it comes to price momentum. If one indicator signals momentum in a certain direction, check the other indicator to see whether it agrees. If their views are split, you may struggle to reach a conclusion that gives you enough confidence to open a position. When both agree, though, traders may feel more confident in taking action.
In the NZD/USD chart below, RSI and MACD both signal momentum shifts in close proximity to one another. In both cases, the RSI slightly leads the MACD. Traders watching this currency pair closely might identify RSI’s signal, then wait to see if MACD aligns—and potentially open or close a position as a result.
Exit a Position When MACD and RSI Diverge
In the same way that traders may open positions when MACD and RSI indicators confirm one another, traders may choose to close out a position when one of these indicators signals a shift in momentum.
Depending on your individual trading strategy, the rationale behind this decision can vary. Some traders will argue that the divergence of one indicator weakens the signal of the other indicator. Others may feel that one signal’s change of momentum may be a harbinger of the other signal’s change of direction and a corresponding shift in price movement.
Regardless of your evaluation, the divergence of MACD and RSI indicators is a notable development and may play a role in your decision to maintain or close out a position.
Use Stop-Losses for Risk Management
While MACD and RSI are popular indicators to pair together because of their proven value over time, it’s possible for these indicators to give false signals—even when combined with one another. As a trader, you should always embrace risk management practices that insulate you against losses resulting from these false signals.
When RSI and MACD agree, the signal they offer may be more reliable and give you more confidence. But they aren’t foolproof, and overconfidence in these indicators can lead to costly losses.
Final Thoughts on Using MACD and RSI Together
The more you test and refine your forex analysis strategy, the more likely it is that combining MACD and RSI will be just one component of a larger, more complex trading strategy.
That said, all traders have their favorite indicators they like to use, and amateur traders may be on the hunt for simple indicators and strategies that can help them find their footing as they gain experience in trading. MACD and RSI can be a profitable combination for both amateurs and experts.
The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.