The Moving Average Convergence Divergence (MACD)
The Moving Average Convergence Divergence momentum indicator is one of the most popular technical analysis indicators used by Forex traders. The Moving Average Convergence Divergence was discovered by Gerald Appel from around the 1960s to the 70s. The MACD was designed to identify trend changes and is often used by many traders to confirm trends in the forex trading systems. It is one of the most used indicator in the trading world by traders globally. This indicator was calculated within 3 steps:
- The MACD line- which is the difference between the 12 and 26 EMA
- Signal Line- day EMA of the MACD line
- MACD Histogram- difference between the MACD and the signal line.
MACD Indicator Formula
MACD = EMA(Close)period1 – EMA(Close)period2
Signal Line = EMA(MACD)period3
the period1 = standard settings are 12 bars
the period2 = standard 26 bars
the perid3 = standard 9 bars
Here are the steps to calculate MACD
- Calculate the 12-days EMA of closing price
Calculate the 26-days EMA of closing price
3. MACD = 12-days EMA – 26-days EMA
4. Signal Line = 9-days EMA of MACD
The Formula for Exponential Moving Average (EMA)
EMA = (SC X (CP – PE)) + PE
SC = Smoothing Constant (Number of days)
CP = Current Price
PE = Previous EMA
The MACD indicator is calculated to show the difference between the fast and slow exponential moving average (EMA) of closing prices in the market. The fast EMA means a short-period moving average, while slow means a long period moving average. The standard MACD period used are 12 days closing price and 26 days closing price (EMA)
Traders often get confused on how to use MACD correctly most especially the beginners under different market conditions. You need to know how to use the MACD when the market is trending and how to technically use it when the market is ranging, the problem most time with traders is that they find it difficult to figure out which market pattern or condition is forming so they end up trading with the wrong strategy at the right time but if only they figure out the right market condition they will be able to apply the right strategy for the market condition they are trading. Sometime if you find out that you a trader is losing money then he or she might be lacking some little secrets that will give him or her an edge just like the profitable traders out in the trading world. Learn to trade MACD the right way and you will see good result.
MACD calculates and displays the difference between the two moving averages at any time. As the market moves, moving averages move with it, widening (diverging) when the market is trending and moving closer (converging) when the market is slowing down and possibility of a trend change arise.
Basics of MACD Indicator
The normal Standard indicator settings for MACD (12, 26, 9) are used in many trading systems, and these are the setting that MACD developer Gerald Appel has found to be the most suitable for both faster and slower moving markets. To get a more responsive and faster performance from MACD one can experiment with lowering MACD settings
The MACD indicator is based on Moving Averages in their simplest form. MACD measures the difference between faster and slower moving average: 12 EMA and 26 EMA (standard).
The MACD line is created when longer Moving Average is subtracted from shorter Moving Average. As a result, a momentum oscillator is created that oscillates above and below zero and has no lower or upper limits. MACD also has a Trigger line. Combined in a simple lines crossover strategy, MACD line and trigger line crossover outperforms EMAs crossover.
when MACD (12, 26, 9) flips over its zero line, it indicates that 12 EMA and 26 EMA on the chart have crossed.
How to know use MACD indicator correctly:
- The MACD lines crossover is a trend is changing.
- The MACD histogram staying above zero line — that means market is bullish, below zero line— that means market is bearish.
- The MACD histogram flipping over zero line — confirmation of a strength of a current trend but we need to know where is the principal trend upside or downside before considering a buy or sell signal.
Trading the MACD Divergence
The MACD histogram diverges from price on the chart — signal of an upcoming reversal also you need to see the big picture which is the trend, knowing whether it is uptrend or downtrend.
The Divergence is found by comparing price shifts on the chart and MACD values. MACD Divergence phenomenon occur because of shifting forces on the Forex market.
Let say, while Sellers may seem to be dominating the market now and price continues to trend down, there already might be signals for an overall weakening of Sellers power. This warning moments can be observed with MACD indicator. What Forex traders would see is that despite price making new Lower Lows, MACD doesn’t confirm that and instead registers a Higher Low, signaling that Sellers are running out of steam and a trend change is on its way. The opposite will be true for traders who want to buy.
How to trade MACD Divergence
When the MACD line (on our screenshot it is a blue line) crosses Signal line (red dotted line) – we have a point (top or bottom) to evaluate. With two most recent MACD line tops or bottoms find corresponding tops/bottoms on the price chart. Connect MACD tops/bottoms and chart tops/bottoms.
With MACD divergence spotted Enter the market when MACD line crosses over its zero point and making sure you see the bigger picture of the trend. Another entry strategy is to find 2 most recent swings high or low on the chart and draw a trend line through them; and then set an Entry order on the breakout of that trend line and wait till MACD cross zero above or below also look at the next two timeframes and see the bigger picture of where the trend is going before placing a buy or sell.
The MACD divergence trading method used not only to predict trend turning points, but also for trend confirmation. A current trend has high potentials to continue unchanged in case no divergence between MACD and price recent tops/bottoms.
Most traders use MACD and it is one of the most widely use indicator. When used correctly, this indicator can help you better spot price movements in both trending and ranging markets. If apply correctly MACD can generate reliable buy or sell crossover signals during a range bound market as well divergences in a trending market.
When there is a crossover and divergence at the same time, it can be very reliable as a trend reversal signal with a classic divergence.
Identify the market condition first, then use the right MACD signal for that market condition and you will become more profitably in trading.
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