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Fast food restaurants seem to be a growing business. This video discusses the MACD technical indicator, the most widely used in trading. The MACD line is the difference between two exponential moving averages, namely the fast-moving average and the slow-moving average. The signal line is the nine exponential moving average of the MACD line. Lastly, the histogram helps determine price momentum. The key takeaways from the video for traders is to understand the components of the MACD indicator and how to effectively use it to determine when to enter or exit trades.
The Infamous MACD Indicator: Understanding its Components and Applications
Introduction: The Rise of Fast Food Chains
Fast food restaurants seem to be popping up all over the place these days. As we pass by major streets or malls, we would often come across a new chain of restaurants, making it harder to decide where to take our kids to eat on a Saturday afternoon. This pattern of proliferation and complexity is quite similar to how trading works. Everywhere you look, you encounter different strategies, indicators, or trading techniques, which could be both intriguing and intimidating. In this article, we will explore one of the most popular technical indicators used in trading – the MACD.
What is the MACD?
MACD stands for Moving Average Convergence Divergence, and it is the most widely used technical indicator in trading. Essentially, the MACD is another way of looking at moving averages, which is a line on a chart that smooths out price movements over a certain period. The MACD is composed of three elements, namely, the MACD line, the signal line, and the histogram.
Understanding the Components of the MACD
The MACD line is the difference between two exponential moving averages, where exponential moving averages are those that spend more time or emphasis on the most recent data, making it less reactive to big numbers falling off out of the equation. The MACD line looks at two moving averages, the fast moving average (defaulted at 12) and the slow moving average (defaulted at 26), to determine their relationship, whether they are converging or diverging.
The signal line, on the other hand, is a nine exponential moving average of the MACD line. This element takes the MACD line and averages it over a nine period look-back. The relationship between the MACD line and the signal line (whether they are crossing above or below) provides signals when to buy or sell and when trends might change direction.
Lastly, the histogram is another visualization of the relationship between the MACD line and the signal line. For instance, if the MACD line is moving up through the signal line, indicating upward momentum, the histogram will also be moving up. On the opposite end, if the MACD line crosses below the signal line, indicating a possible trend reversal, the histogram bars will show below the center line.
The Applications of the MACD
Now that we have a basic understanding of the MACD, let us explore its applications. Generally, the MACD is used to enter a market when the MACD line crosses above or below the signal line. A crossover from below to above provides a buy signal, while a cross from above to below indicates a sell signal.
Moreover, the MACD line can also signal a trend reversal. For example, if the market trends upwards, and the histogram moves back down, and the MACD line crosses through the signal line, it suggests that the trend might be reversing. It is a good preemptive signal to show trends might change direction.
The histogram can also indicate an increase or decrease in momentum. As the histogram moves up, momentum is increasing, and when it starts to roll off, it hints that the momentum might be waning, and it might be time to get out of your current positions.
Understanding the MACD in Practice
To make things more comprehensive, let us put the MACD in practice. Here is a regular price chart with a 12 moving average, which is the fast moving average, and a 26 moving average, the slower moving average.
As seen in the chart, the fast moving average is moving with the price and does not show much on its own. However, when the slower moving average converges with the faster moving average, a trend is forming.
With the MACD indicator, trading enthusiasts can better visualize the relationship between these two moving averages. By adding the MACD to the chart, the blue line represents the difference between the two moving averages. In the instance of an upward trend, the MACD line will be moving up through the signal line, and the histogram bars will start to move up as well. On the other hand, when the trend starts to reverse, the MACD line will cross below the signal line, and the histogram bars will dive below the center line, showing a downward trend.
Conclusion: The Importance of Understanding the MACD
In conclusion, the MACD is a technical indicator used in trading, which employs moving averages to show the relationship between two moving averages. The MACD is composed of three elements, the MACD line, the signal line, and the histogram. Understanding the MACD is crucial in identifying signals when to buy or sell and when trends might change direction. Always remember that the MACD should not be used on its own, but in combination with other trading indicators to make a more informed trading decision.
