NoaFX Tutorial

5.4 The RSI & MACD Combined

As with each and any indicator, each of them will have their own strengths and weaknesses.

We have studied 3 different indicators so far;

  • The Moving Average
  • THE MACD
  • The RSI

As with the MAs and the MACD, we can use its studies to signal change of market trends. As with the RSI, we can use this indicator to study the strength or state of trend formation at that particular point in time.

Now, let us observe how trade setups can be placed using a sample chart and with each of these indicators.

Trading Example Using MACD

Given below is the Hourly (H1) Chart of GBP/JPY. From plain observations, it is quite clearly a downtrending period for this particular currency pair.

Now, let us introduce the MACD indicator to this setup. Using this indicator, we will trade based on the signals it generates.

On your own MT4 terminal, pull up the GBP/JPY, Hourly chart, between the 6th Nov'09 till the 12th Nov '09. With MACD default settings at 12, 26 and 9.

In this exercise, we would like you to pick up all the possible entry and exit points based on these rules;

  • You will buy/sell based on the MACD Difference and Signal Line intersecting each other. Therefore,
    • a buy position will be opened when the difference line intersects the signal line from below, in an upwards direction.
    • a sell position will be opened when the difference line intersects the signal line from above, in a downwards direction.
  • Your order management routines are;
    • To exit when in profit of 60 pips
    • To exit when in loss of 30 pips.
  • The assumptions made are;
    • Due to the signals lagging, we will only take action at the next bar after the MACD intersection has happened.
    • To standardize our exercise, our open/buy prices will always be at the close of the candle bar.
  • Your overall discipline is ;
    • You will stop trading when you have 2 losses in a row.
    • You will not have more than 2 positions open concurrently.

Note: Please have this exercise done before proceeding any further.

Based on this exercise, you should have picked out all, or more, of these possibilities as shown below.

Here is a summary of positions placed and how they had turned out;

  • Sell Position – Stopped Out – 30 Pips Loss
    • Overall Acct Balance – negative 30 Pips
  • Buy Position – Stopped Out – 30 Pips Loss
    • Overall Acct Balance – negative 60 Pips
  • Sell Position – Profit Taken – 60 Pips Profit
    • Overall Acct Balance – 0 Pips
  • Buy Position – Stopped Out – 30 Pips Loss
    • Overall Acct Balance – negative 30 Pips
  • Sell Position – Profits Taken – 60 Pips Profit
    • Overall Acct Balance – positive 30 Pips
  • Buy Position – Stopped Out – 30 Pips Loss
    • Overall Acct Balance – 0 pips
Trades Summary
  • Overall Trades taken: 6
  • Profitable trades: 2
  • Losing trades: 4
  • Win percentage: 33%
  • Average profits: N/A

As we can see, the MACD, by itself, can be a losing strategy overall.

Trading Example Using RSI

Let us repeat the same exercise again with the usage of the other indicator we have covered so far, the RSI.

Assessing the same chart setup, let us have the RSI (5) based to pick up the trades.

In this exercise, we would like you to pick up all the possible entry and exit points based on these rules;

  • You will buy/sell based on the RSI Indicator. Therefore,
    • a buy position will be opened when the RSI Indicator leaves the oversold area from below, in an upwards direction.
    • a sell position will be opened when the RSI Indicator leaves the overbought area from above, in a downwards direction.
  • Your order management routines are;
    • To exit when in profit of 60 pips
    • To exit when in loss of 30 pips.
  • The assumptions made are;
    • Due to the signals lagging, we will only take action at the next bar after the RSI move leaving the area has happened.
    • To standardize our exercise, our open/buy prices will always be at the close of the candle bar.
  • Your overall discipline is ;
    • You will stop trading when you have 2 losses in a row.
    • You will not have more than 2 positions open concurrently.

Note: Please have this exercise done before proceeding any further.

Based on this exercise, you should have picked out all, or more, of these possibilities as shown below.

Here is a summary of positions placed and how they had turned out;

  • Sell Position – Stopped Out – 30 Pips Loss
    • Overall Acct Balance – negative 30 Pips
  • Sell Position – Profit Taken – 60 Pips Profit
    • Overall Acct Balance – positive 30 Pips
  • Buy Position – Stopped Out – 30 Pips Loss
    • Overall Acct Balance – 0 Pips
  • Sell Position – Stopped Out – 30 Pips Loss
    • Overall Acct Balance – negative 30 Pips
  • Buy Position – Profit Taken – 60 Pips Profit
    • Overall Acct Balance – positive 30 Pips
  • Buy Position – Profit Taken – 60 Pips Profit
    • Overall Acct Balance – positive 90 Pips
Trades Summary
  • Overall Trades taken: 6
  • Profitable trades: 3
  • Losing trades: 3
  • Win percentage: 50%
  • Average profits: 15 Pips per trade

In this particular example, the RSI Indicator has proved to be slightly more profitable, achieving 50% probability and 90 pips overall in profit.

However, given the strengths and weaknesses of both indicators, can we combine them both to give us superior trade setups?

Trading Example Using both the MACD & the RSI

Let us repeat the same exercise again. However, this time around we will use both indicators to further filter and improve the quality of our trade setup.

Assessing the same chart setup, let us have the MACD (12, 26, 9) and the RSI (5) based to pick up the trades. This time around, we will take a longer sample as to give us more signals.

In this exercise, we would like you to pick up all the possible entry and exit points based on these rules;

  • You will first look for a signal on the MACD Indicator. Therefore,
    • a buy signal will be generated when the difference line intersects the signal line from below, in an upwards direction.
    • a sell signal will be generated when the difference line intersects the signal line from above, in a downwards direction.

Next

  • You will then look for a confirmation signal on the RSI Indicator. Therefore,
    • a buy position will be opened when
    • the RSI Indicator leaves the oversold area from below, in an upwards direction,
      or
    • the RSI Indicator is about to enter or entering the overbought area, in an upwards direction, as the MACD indicator generates a buy signal.
    • a sell position will be opened when
    • the RSI Indicator leaves the overbought area from above, in a downwards direction,
      or
    • the RSI Indicator is about to enter or entering the oversold area, in a downwards direction, as the MACD indicator generates a sell signal.

You will not take a trade when both signals are not in agreement with their trade direction.

You will not take a trade when the market is ranging as given by the RSI value 50. As a gauge, we can take the values between 45-55, as such a ranging market indicator value.

  • Your order management routines are;
    • To exit when in profit of 60 pips
    • To exit when in loss of 30 pips.
  • The assumptions made are;
    • Due to the signals lagging, we will only take action at the next bar after the MACD intersection has happened.
    • To standardize our exercise, our open/buy prices will always be at the close of the candle bar.
  • Your overall discipline is ;
    • You will stop trading when you have 2 losses in a row.
    • You will not have more than 2 positions open concurrently.

Note: Please have this exercise done before proceeding any further.

Based on this exercise, you should have picked out all, or more, of these possibilities as shown below.

Trades Summary

Without filtering by alignment of both indicators,

  • Overall Trades taken: 22
  • Profitable trades: 6
  • Losing trades: 16
  • Win percentage: 27.3%
  • Average profits: -13 Pips per trade

Most importantly, now with filtering with confirmation from each other indicator, notice the performance.

  • Overall Trades taken: 11
  • Profitable trades: 5
  • Losing trades: 6
  • Win percentage: 45%
  • Average profits: 11 Pips per trade

Therefore, notice that we have been able to increase our profitability to a much higher value by just introducing another indicator. So, does this mean by having more additional indicators, we can further increase our trade setups' quality?

Yes and no. Yes, if you add the right indicators which can tell the different aspects of the market to give you the right "equation" to support your trade studies. Notice that when we trade with the MACD, we chose to add the RSI and not any of the Moving Averages we had covered earlier. Likewise, each indicator studies a different aspect of the market and you need to understand what it is studying before using it blindly.

Therefore, which indicator should we use with another indicator?

We will be studying in depth of the various indicators there are out there and explaining the rationale of which indicator complements another and which contradicts. Others are just plain redundant and old age saying of "the more the merrier" doesn't apply here!

In our next Forex Whiz module, we will cover on;

  • Market Psychology of Numbers – The Unsaid Rule.
  • How to define your stop loss and take profit levels to always be profitable?
  • Identifying Trending and Ranging Markets and trading them both!
  • Key Market Patterns that tell you what is coming again and again.
  • The Trend Funnel Strategy. Using Market feedback to give you your trade setups. No more predicting the market!
  • Introduction to Automated Trading – Trade the markets without you being there.
  • And get your own Expert Advisor – Name to be advised – to start trading the market on auto pilot!

NoaFX FX Beginner's Tutorial can be accessed by anyone without any restriction.

To access our Advance FX Tutorial please login using your existing account details or open a new account.

close