The MACD is one of the most popular and broadly
used indicators for forex and stock trading. MACD stands for moving average convergence
divergence because it requires moving averages as its input. The MACD is one of the simplest and most effective
momentum indicators available. The MACD turns two trend-following indicators,
moving averages, into a momentum oscillator by subtracting the longer moving average from
the shorter one. The moving average convergence divergence
is a relatively easy-to-use tool, but it is crucial to understand it fully before attempting
to trade using its signals. Let’s take a close look at the structure
of the MACD indicator and its default settings. The MACD indicator consists of three components,
namely two lines and a histogram. • The MACD line is the faster line on the
indicator. This line reacts faster to price changes and
is more sensitive, moving above and below the second line of the indicator. • The second line of the indicator is the
MACD signal line. This line is slower and it gets frequently
breached by the faster MACD line. • We also have the MACD histogram – the
MACD histogram simply represents the difference between the MACD line and the signal line. The bigger the gap between the lines, the
higher the bars that the MACD histogram will display. If the two moving averages come together,
they are said to be ‘converging’ and if they move away from each other they are ‘diverging’. So the MACD is a trend-following momentum
indicator that shows the relationship between two moving averages of price. The MACD line is calculated by taking the
difference between a longer-period and shorter-period exponential moving average. Exponential averages are used because they
respond more quickly to changes in price, since more weight is placed on the most recent
price compared to the earlier prices. You can use any length of period you wish
when calculating the various exponential moving averages, although the 12-, 26-, and nine
period averages are most frequently used. To understand how the MACD can be used in
trading, you first need to know how it works. This chart shows the relationship between
the two moving average lines and the MACD for EUR/JPY. The top part of the chart contains the daily
prices for the currency pair, as well as a 12- and 26 exponential moving average. The bottom part contains the MACD line, the
signal line, the histogram and the zero level. 3 things stand out from this chart. First, you can see that as the two moving
averages move away from each other, the MACD line rises or falls. Second, you can see that when the two moving
averages cross, there is a corresponding crossing of the zero level by the MACD line. Third, when the signal line and MACD line
averages cross, there is a corresponding crossing of the zero level by the MACD histogram So, when the indicator is plotted on a chart,
the most important aspect is the interaction between the two lines, as well as their positions
relative to the zero line. • When the MACD line is above the zero line,
it indicates that the shorter-period moving average is above the longer period moving
average, which in turn indicates that the market is bullish
• When the MACD line falls below the zero line, the shorter period moving average is
less than the longer-period moving average, indicating that demand is more bearish than
it was in the past • If the fast line is above the slow line,
MACD-histogram is positive and plotted above the zero line, suggesting a bullish bias
• On the other hand, if the fast line is below the slow line, MACD-histogram is negative
and plotted below the zero line, indicating a bearish momentum. In general, MACD indicators are used in one
of three ways—crossovers, overbought/oversold conditions, or divergences. Crossovers are probably the most popular use
of MACDs: a sell signal is generated when the MACD crosses below the signal line, and
a buy signal is generated when the MACD crosses above the signal line. In addition, the locations of these crossovers
in relation to the zero line are helpful in determining buy and sell points. Bullish signals are more significant when
the crossing of the MACD line over the signal line takes place below the zero line. Confirmation takes place when both lines cross
above the zero line. Here are some examples of MACD crossovers. Using the MACD in this way makes it a lagging
indicator. Just like moving averages—which are also
lagging indicators—the MACD works best in strong trending markets. Both the MACD and moving averages are intended
to keep you on the “right” side of the market (on the long side during uptrends and
on the short side or out of the market altogether during downtrends), meaning you buy and sell
late. While you may enter a trade after the beginning
of a trend and exit before the trend comes to an end, I would use this indicator as a
buffer to reduce risk, not as the main signal. Another use for the MACD is to determine when
a given security or index is either overbought or oversold. An overbought condition may exist when the
price has experienced a significant upward move. At some point you expect that the price might
fall and return to some more “normal” level. Likewise, when the price has seen an extended
downward movement, an oversold condition may exist. At some point the price may be expected to
rise to some normal level. A security or index may be overbought when
you see the MACD rise significantly. During this period, the shorter moving average
used in the MACD calculation is rising faster than the longer moving average. This is an indication that the price is overextending
itself and, at some point, may reverse its course. When using the MACD to identify periods when
a security or index is overbought or oversold, the best buy signals come when the MACD line
and the signal line are below the zero line—as the security or index may be oversold. Sell signals are generated when the lines
are above the zero, where they may indicate an overbought condition. Unlike other oscillating indicators such as
the rsi (relative strength index), there is no pre-determined overbought or oversold condition. High and low MACD levels are relative, depending
on the security or index you are examining. You may need to study the behavior of the
MACD over time before you can determine when the price is overbought or oversold. Looking at the MACD behavior over an extended
period of time, you may be able to discern patterns where the MACD may rise or fall to
relatively similar levels, at which point the price will fall or rise, respectively—
and with it the MACD lines. The third popular use of the MACD is to identify
those times when it diverges from the price. A divergence occurs when the trend of the
price does not agree with that of the indicator. In other words, an indicator trends in one
direction while the price goes another, or does not go in the same direction. MACD divergences tend to preface a reversal
in the current price trend. A bullish divergence forms when a price records
a lower low and the MACD forms a higher low. The lower low in the price affirms the current
downtrend, but the higher low in the MACD shows less downside momentum. A bullish divergence takes place when the
MACD is making new highs even though prices fail to reach new highs. Greater importance should be placed if the
price makes a new relative low while this pattern develops. Furthermore, both signals carry greater significance
if they occur at relative overbought or oversold levels. You can use the MACD histogram to search for
divergences, but also the MACD line and the signal line. The strongest signals appear when there is
a double divergence, on both the histogram and on the signal and MACD line. Here are some examples of double divergence. This is my favorite way to use the MACD, and
the most effective way. Trading MACD divergence, if done correctly,
can provide you with a real edge in the market. It can be a powerful early indicator of trend
reversals when combined with price action and support and resistance. Now, regarding timeframe. There is no such thing as a ‘best’ time
to use the MACD indicator, this will be completely down to you, your personal preferences and
trading plan. However, daily signals are more significant
than 5 minute signals, just as weekly signals carry more weight than 15 minutes signals. One common technique is to track the behavior
of the MACD on a daily basis. However, instead of entering or exiting a
trade based on a daily signal, you could refer to the weekly chart to see where the MACD
is. For example, if you receive a buy signal from
the daily MACD and you see that on the weekly chart the MACD is in a bullish “condition,”
you may wish to enter a long position. However, if the weekly MACD is in an overbought
condition, you will probably want to ignore the buy signal from the daily MACD. As always, if you learned something new, make
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