Applying the MACD to Bearish Reversal Patterns

 The MACD doesn’t measure overbought levels. The MACD is a measure of trend and momentum. When applying the MACD to bearish reversal patterns, the indicator is used to detect when shifts from bullish to bearish momentum occur. These shifts can serve as a leading indicator to a reversal in trend. Additionally, the shift from bullish to bearish momentum can lend credence to a bearish reversal pattern.

Figure 11.20

Example:

Shares of American Airlines (AMR) traced a head and shoulders top, which eventually lead to a huge reversal of a long-term bullish trend as shown in Figure 11.20. The stock confirmed the head and shoulders top when it broke down below horizontal support at the $30 level.

The MACD generated a sell signal several months before AMR confirmed its head and shoulders top. In fact, the sell signal emerged in advance of the right shoulder forming.

The sell signal revealed a long-term shift in momentum from bullish to bearish. When combined with the bearish reversal pattern, the shift in momentum signaled that a drop in AMR was likely.

Figure 11.21

Example:

Shares of American International Group (AIG) traced triple top, bringing to end a bullish trend and starting a new bearish trend as shown in Figure 11.21.

The MACD signaled a shift in momentum early in the formation of the triple top. The MACD starting declining after the first time AIG rolled from the horizontal resistance level at $72. A second sell signal was generated after AIG rolled over from the $72 horizontal resistance level for the third time. The sell signal came well in advance of the confirmation of the triple top.

Notice how the MACD continued to decline as the triple top took shape. The MACD revealed a build-up in bearish momentum. Think of the MACD a weight around AIG. The stock could keep itself up for only so long before the bearish momentum dragged it lower. This action in the MACD combined with the formation of the triple top served as a strong indication that AIG would likely head lower.

Technical indicators are powerful tools that can help you to organize and measure movements in currency pairs. A lot of traders, especially beginners, are led to believe that technical indicators are some sort of secret that will take them down the path to riches. While technical indicators can be used to determine objective entry points, they are far from the holy grail of forex trading.

The most common application of technical indicators is determining entry points. But you can use technical indicators in different, unique ways. You can use these tools to exit both profitable and losing trades.