MACD stands for Moving Average Convergence Divergence. The MACD indicator is a trend-following, momentum indicator. Also, a very popular indicator used by traders.
The best environment to make profits in the forex market are trending markets. Ranging markets should be avoided.
A market is ranging when it is moving back and forth within a price range. Profits cannot be made since the price is going back and forth within a boundary.
The MACD is a good technical tool for determining bullish and bearish trends.
When a MACD is placed on charts, three sets of numbers are displayed. These are the settings of the MACD indicator.
- The first is the number of periods that are used to calculate the faster-moving average.
- The second is the number of periods that are used in the slower moving average.
- And the third is the number of bars that are used to calculate the moving average of the difference between the faster and slower moving averages.
The default settings for a MACD indicator are usually: (12, 26, 9).
It can be interpreted as;
- The“12” is the period for the faster-moving average. It calculates the mean of the previous 12 bars.
- The “26” represents the period for the slower moving average. It calculates the mean of the previous 26 bars.
- “9” indicates the number of bars used to calculate the difference between the two moving averages.
Note: The moving averages used in the MACD indicator are exponential moving averages.
Components of a MACD Indicator
The MACD indicator is made up of three components;
- The MACD Line
- The Signal Line
- Histogram
The MACD is an indicator that shows the relationship between two moving averages of a particular currency pair. The result is displayed as the MACD line.
The signal line is a moving average of the MACD line. The period of the signal can be adjusted to your liking.
The histogram indicates the magnitude of bullish or bearish momentum. It graphs the difference between the MACD and the signal line.
MACD Indicator Crossover
As mentioned above, the MACD indicator has two lines; MACD and Signal lines.
The MACD line reacts faster than the signal line. When the MACD line crosses the signal line, they start to move away from each other. This indicates the start of a new trend.
The histogram always reads zero when this cross-over occurs. This is because the difference between the lines when they crossover is zero as well.
When the fast line crosses ABOVE the slow line, indicates the start of an uptrend. The histogram will be above the baseline.
Conversely, if the fast line crosses BELOW the slow line, it is a bearish signal indicating the start of a downtrend. The histograms display below the baseline in this case.
On both occasions, the histogram reading was zero when the crossover occurred.
It is important to note that crossovers are more reliable when they conform to the present trend.
MACD Divergence
In addition to MACD crossovers, traders also use divergences to make trading decisions. Divergence occurs when the MACD indicator forms highs and lows that diverge from the current highs and lows on the price.
A bullish divergence occurs when the indicator forms two rising lows but the price forms two falling lows.
Also, the MACD can form two falling highs that correspond with two rising highs on the price. This is a bearish divergence.
Just like with MACD crossovers, divergences are more reliable when they conform to the present trend.
MACD vs RSI
Even though they are both momentum indicators, they give different signals sometimes. This is because different variables are measured.
Momentum indicators are tools that measure the strength and weakness of a currency pair’s price.
The Relative Strength Index is identical to the stochastic oscillator because it displays over-bought and oversold regions. RSI tracks over-bought and oversold regions using the velocity of price movements and recent price levels.
On the other hand, a MACD shows the relationship between two moving averages and a trend’s momentum.
Also, both of these indicators are lagging indicators. Lagging indicators are indicators that stall behind current price action.
The MACD stalls behind price because its EMAs find the average of historical prices. While the RSI lags because it compares recent price gains against price losses.
However, they both can be viewed as leading indicators because they predict new trends.
Summary: The MACD Indicator Explained
The MACD indicator is an amazing tool for technical analysis. It is most accurate when used for swing trading.
- You can get the full tutorial on how to use the MACD indicator here
- Read how to use the moving average envelope here
- Three of The Best Indicators For Day Traders
A major problem with this indicator is that it gives out “fake signals” often as most lagging indicators do. Sometimes, the MACD and signal line crosses which signifies trend reversals but it does not occur.
To filter these fake signals out, the MACD can be used with another indicator.
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