The MACD - RSI Technical Indicator Trading Strategy

What is a technical indicator?

Technical indicators are mathematical formulae that use price data, such as the opening and closing prices and price highs and lows. Overlays are presented on top of the price, while underlays are displayed beneath the candlestick chart.

In any market, technical indicators can be used in day trading. Forex trading, commodity trading, and indices trading are popular short-term trading sectors where technical indicators can be used and are particularly popular with crypto traders.

Technical indicators convey price movement in a distinct visual style that can teach traders about trends, volatility, overbought or oversold circumstances or give buy and sell signals.

Types of technical indicators

There are 3 basic types of technical indicators, each of which performs a separate function from the others. This means there is no conflicting information, and each technical indicator compliments the others.

These 3 functions are trend following, momentum, and volatility.

The Best Technical Indicators To Combine

The following are the best technical indicators for CFD trading. Over time, you might change the settings on the indicators, use customized indicators, or even create your own custom technical indicator.

  • Moving Average Convergence Divergence for Trends and Transaction Signals
  • Relative Strength Index (RSI) for Momentum

1) Moving Averages Convergence Divergence

The Moving Average Convergence/Divergence indicator is a momentum oscillator primarily used to trade trends. Although it is an oscillator, it is not typically used to identify overbought or oversold conditions. It appears on the chart as two lines that oscillate without boundaries. The crossover of the two lines gives trading signals similar to a two-moving average system.

MACD crossing above zero is considered bullish while crossing below zero is bearish. Secondly, it is considered bullish when MACD turns up from below zero. When it turns down from above zero, it is considered bearish.

The indicator is bullish when the MACD line crosses from below to above the signal line. The further below the zero line, the stronger the signal.

The indicator is considered bearish when the MACD line crosses from above to below the signal line. The further above the zero line, the stronger the signal.

During trading ranges, the MACD will whipsaw, with the short line crossing back and forth across the signal line. Users of the MACD generally avoid trading in this situation or close positions to reduce volatility within the portfolio.

The divergence between the MACD and the price action is stronger when it confirms the crossover signals.

2) Relative Strength Index

RSI is an oscillator displayed as an underlay indicator and fluctuates between zero to one hundred readings. The maths behind the indicator is comparing the size of 'up moves' versus 'down moves' – so the idea is it compares the 'relative strength' of the bulls versus the bears.

It is most commonly used to find overbought and oversold market conditions. The price might have moved too quickly and could be about to reverse. Traders will also compare the swings in the RSI indicator with the prices to find divergence between the two. Divergence is another signal to show the current price move might be about to reverse.

On short timeframes, the price can change direction quickly. Momentum indicators like RSI are leading indicators, meaning the RSI will often change direction before the price. This can signal traders early warning to exit a trade before the price reverses. The drawback is that RSI can display false signals, suggesting a trend will change when it doesn't.

The default settings for RSI are 14 days, but dropping down to lower timeframes, like the one-hour chart, will produce an RSI constructed using 14 hours of price data instead.

Putting it all together into a trading strategy

Good short-term trading opportunities come about when these two indicators work together.

  • The MACD shows the trend and trend reversals
  • The RSI shows the momentum of the price move and when the momentum slows.

These indicators' combinations can offer a great deal of insight regarding price momentum. If one indicator points out momentum in a specific direction, verify the other indicator to check whether it agrees. If the views are split, you may struggle to conclude should you open a position. When both read the same, a trader will find a high probability position to trade.

To learn how to use these indicators or to try them with the charts, visit our webtrader platform.