Dubbed as the king of oscillators, Moving Average Convergence/Divergence (MACD) can be used well in trending or ranging markets due to its usage of moving averages that provides a graphic demonstration of changes in momentum.
Simply, as its name suggests, the MACD is about the convergence and divergence of the two moving averages. Convergence happens when the moving averages move towards each other, and divergence occurs when the moving averages move away from each other.
As defined by Investopedia, MACD is a trend-following momentum indicator that displays the relationship between two prices’ moving averages. It is one of the simplest and most effective momentum indicators available, and is applicable to daily, weekly or monthly charts.
Traders can look for signal line crossovers, centerline crossovers and divergences to create signals.
However, keep in mind that due to the unbounded nature of the MACD, it is not principally suitable for identifying overbought and oversold levels.
To calculate this indicator, one must subtract the longer 26-day exponential moving average (EMA) from the shorter 12-day EMA. A nine-day EMA of the MACD, termed the "signal line", is plotted on top of the MACD, working as a prompt for buy and sell signals.
In less technical terms, the MACD turns moving averages into a momentum oscillator by subtracting the longer EMA from the shorter EMA. As a result, the MACD brings trend following and momentum all in one indicator.
The shorter EMA is faster and responsible for most MACD movements, while the longer EMA is slower and less sensitive to price changes in the core security.
(image by dailyfx.com)
Like all indicators, MACD is best paired with an identified trend or range-bound market. There are two things one should find to derive pointers from this indicator:
· Firstly, identify the lines in relation to the zero line which pinpoints an upward or downward bias of a forex pair. It would be wise to take crossovers of the MACD line in the direction of the trend.
· Secondly, identify a crossover or cross under of the MACD line to the Signal line for a buy or sell trade correspondingly. Once entered the trade, you can set stops below the recent price extreme before the crossover, and place a trade limit at twice the amount risked.
The MACD wavers above and below the zero line as the moving averages converge, cross and diverge. This zero line is also known as the “center line”. This crossover signals that the shorter EMA has crossed the longer one, and often acts as a level of support and resistance for the indicator.
The direction is dependent on the direction of the moving average cross. A positive MACD signifies that the 12-day EMA is above the 26-day EMA. Positive values also surge as the shorter EMA deviates further from the longer EMA. This means upside momentum is increasing.
Contrarily, a negative MACD shows that the shorter EMA is below the longer EMA. Negative values increase as the shorter EMA separates further below the longer EMA, and this would imply that the downside momentum is growing.
(image by onlinetradingconcepts.com)
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