Ready to learn how to interpret MACD and RSI?
As a general rule, to interpret MACD and RSI, traders can look for a MACD bullish or bearish crossover and use RSI to confirm the trend. A trend is present if the RSI is above 50 or below 30, and it is in a consolidation if the value is within 30 to 50.
However, when there is consolidation, traders need to protect their trading accounts.
- Combining MACD and RSI
- MACD Bullish Cross and RSI is above 50
- MACD Bearish Cross and RSI is below 30
- MACD Bullish Cross/Bearish Cross and RSI is between 30 to 50
Most traders when starting out probably may have heard of MACD indicator.
The MACD indicator is popular to short-term traders considering that it can identify fast the short-term trend. (source)
However, since MACD is a combination of two moving averages, the signals derived from the indicator are usually too late.
To reduce the effects of being late, advance traders will have to confirm if there is really a trend.
Another indicator that works well with MACD is the RSI.
RSI is a technical indicator based solely on the price of an asset or security.
When the period is smaller, the technical indicator usually mirrors the price of a stock.
It usually mirrors the price of the stock because it is faster than the MACD indicator.
Combining MACD and RSI
As you may already know, MACD is a momentum indicator that shows the relationship between two moving averages.
It is a trend-following, lagging indicator, which can identify entry and exit points for trades. RSI is another momentum indicator, but it was developed by J. Welles Wilder and it has become one of the most popular trading indicators in financial markets.
In this article we will explain how to combine MACD with RSI in order to create a trading strategy that will be more accurate than MACD or RSI alone.
Below are the three types of interpretations in which traders can use to interpret both MACD and RSI.
The first type is for long positions, and the next is for short positions.
The third type is for advance traders who can get in and out quickly. It is the least recommended strategy, considering the amount of risk involved.
MACD Bullish Cross and RSI is above 50
When there is a bullish cross of MACD, the asset or stock may go up in the short-term.
If the RSI is also above 50, there is usually a high probability that the security is strong.
When two indicators are bullish, the signals from both indicators should be reliable.
However, do not apply this interpretation to actual trading unless you’ve done back-testing.
Back-testing is the only way professional traders know that a trading strategy works.
For example, select a stock or an index and then record the price actions after each bullish MACD cross and RSI above 50.
What usually happens after the signals?
Record the number of wins and losses.
Finally, make a conclusion.
This process is a method used to backtest a strategy manually.
However, Amibroker can back-test any trading strategy through a computer which can save a lot of time.
MACD Bearish Cross and RSI is below 30
This signal is telling traders to sell.
The MACD is an indicator which measures the difference between two exponential moving averages of prices. When the MACD crosses its signal line, from above it is usually bearish.
Similarly, when RSI (Relative Strength Index) falls below 30, it is a bearish sign and traders should sell their shares.
Why is it a sell signal?
Well, both RSI and MACD show a bearish trend.
However, MACD is for timing the entries and RSI is for determining the trend.
An overbought MACD is a signal to sell the stock or asset whenever there is a clear bearish trend.
In this interpretation, the stock is still going down given that the value of RSI is below 30.
Years ago, traders would have bought the stock if it cross the 30 level from above.
Yet, if one looks at the MACD at overbought levels, losses is avoidable.
For example, RSI is <30 and MACD is above 70 is a high probability to sell for professional traders.
The Pros usually need at least one confirmation before considering taking trades in the market.
They even use back testing tools for them to see the results firsthand.
MACD Bullish Cross/Bearish Cross and RSI is between 30 to 50
The third type helps traders understand when there is a trend.
When there is no trend, the market is probably in consolidation.
In a consolidation phase, the market usually becomes too difficult to trade.
It is too difficult because the market range is expanding and contracting without predictability.
If traders can not predict the direction of a stock price, it is better not to trade the security for the time being.
For example, when there is a bullish or bearish cross in MACD and RSI is inside the 30 to 50 range, the market is in consolidation.
Now, many traders often try to buy and sell on the tops and bottoms under this type trading environment.
However, if people buy and sell a stock at the same price, will they make any money?
When the market is expanding, the goal is usually to take the stops at the top and the bottom of the price range.
Say, a seller short sells when MACD is above 70, the market makers may run the stops and drive the price back into the range.
When the market is contracting, the range becomes smaller and smaller for a long period.
It may seems nothing is happening and traders who buy and sell shares may lose patience and close their trading positions.
Then after they moved away from the market, that is the time the market moves 20% or more.
Combining MACD and RSI usually helps traders avoid trading markets that are not going anywhere.
In this type of market environment, there are many available strategies people can use.
However, for new traders, it is better to avoid markets that are still in consolidation.
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