Many traders use MACD in Forex, Stocks, Options and other markets to identify trends, entry points and exit points.
Moving Average Convergence Divergence, better known by the acronym MACD is a well-known technical analysis indicator used by forex traders of all experience levels. While many traders use MACD in their forex strategies, the indicator is popular with stock traders and even cryptocurrency traders.
As the name suggests, the Moving Average Convergence Divergence indicator incorporates Moving Averages within its formula. More specifically, two Exponential Moving Averages (EMAs). The terms Convergence and Divergence relate to the two Moving Averages coming together and moving away from one another respectively.
The MACD is used as a trend following indicator and a momentum oscillator which makes the MACD in forex a dual purpose indicator. Not only will it help you to confirm trends but also when they will conclude. Dispute MACD being both a trend and Oscillator indicator, you will find this tool in the Oscillator category of your trading platform.
What is an Oscillator
An Oscillator is something that moves back and forth, crossing a central point each time it does. In the context of forex technical analysis indicators, Oscillators are used to signal changes in the momentum of price.
The consensus is that as momentum drops in an uptrend, it highlights that buyers have stopped buying, and vice versa. This family of indicators helps traders to view changes in the strength of a trend and upcoming turning points.
While the MACD is considered a type of Oscillator, the Stochastic Oscillator, Parabolic SAR, and Relative Strength Index are all also found in the Oscillator indicator category.
The Origin of MACD Forex Indicator
Although the MACD indicator is popular with forex traders and comes preinstalled on many trading platforms, the indicator was originally created for trading stocks. In the 1970s a professional money manager, investment advisor and author called Gerald Appel created the indicator.
Besides his expertise in trading and investing, Appel is a qualified psychotherapist which is a skill that provided him with an upper hand as a trader.
How MACD is Calculated
Unlike Moving Averages, the MACD indicator is not overlaid on top of the price chart but shown in a stand-alone panel below the price chart. The indicator is typically composed of three elements which are two lines and one histogram. In some trading platforms, the histogram is negated. See the below image for reference.
**Include a chart of your trading platform or remove that last sentence**
Blue Line: This line is known as the MACD Line. It represents the difference between two Exponential Moving Averages. One of the EMAs being a Short Cycle, typically 12-periods and the other is a Long Cycle, usually being 26-periods. Therefore this line is a 12-period EMA minus a 26-period EMA.
Red Line: This line is known as the MACD Signal Line. It is an EMA of the Blue Line. Typically this EMA is based on 9-periods. This line is often known as the slow line because it’s a moving average of a moving average.
Greed Dashes: This feature is the MACD Histogram. It highlights the difference between the MACD line and the Signal Line. As the Blue Line and Green Line crossover the difference is zero and the Histogram will be tiny if it’s present at all. When the Histogram is below zero, it represents a bearish trend. If it’s higher than zero, it represents a bullish trend. The larger the Histogram, the further away from the Blue Line and Red Line are from each other.
How to Trade with MACD in Forex
The most common way traders use MACD in Forex is by observing the Signal Line crossing over the MACD Line or when the MACD Histogram transitions from being positive to negative and vice versa. A less common application is to look for Divergence.
Signal Line Crossovers
The most common way to interpret signals from the indicator is when the Signal Line meets and crosses the MACD Line. When the Signal Line crosses it signals a change in the trend. When the MACD Line crosses above the Signal Line, it represents a bullish signal. Likewise, when the MACD Line crosses below the Signal Line, this represents a bearish signal.
Another great feature of this indicator is that as the Histogram shifts closer to the Zero line or starts to reverse, you get a fair warning that the lines could meet soon.
Zero Line Crossovers
The Zero Line is sometimes referred to as the Base Line. When the MACD Line crosses from below the Zero line to above, it signals a bullish crossover. Alternatively, when the MACD Line crosses from above the Zero Line to below it, that indicates a bearish crossover.
In general, Zero Line crossovers are considered as a weaker signal than the Signal Line crossover that is described above. A Zero Line crossover can be helpful as a confirmation of the direction of the trend.
Divergence
A more sophisticated way to use the MACD indicator is to look for Divergence. Divergence occurs when the market makes lower lows or higher highs as it trends up or down. However, if the MACD lines aren’t following and fail to also create new lows or highs, then a trend reversal could be expected.
When the price chart and MACD indicator are not in consensus, then there is a strong indication that the trend is exhausting. If there are two failed lows or highs on the candlestick price chart that do not match with the MACD indicator, then the reversal could be quite significant.
False Signals
As is the case with any forex trading indicator, the MACD is not exempt from creating false signals. False signals are likely because the indicators are based not just on moving averages, but moving averages based on moving averages which cause the indicator to lag somewhat.
It’s recommended to complement the MACD with other indicators to help filter out any false signals.
Should you Use MACD in Forex?
Many Forex traders favour the MACD indicator and for a good reason. It works as a nifty two-in-one tool that confirms trends and highlights possible changes.
The MACD is a mainstay in the online trading community and comes equipped with most trading applications, be it on the desktop, web or even mobile device.
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