The Secret Mindset
The MACD is a momentum indicator used in trading to show the relationship between two moving averages of price. It consists of two lines and a histogram. The MACD is used in three ways – crossovers, overbought and oversold conditions, and divergences. It is best used in strong trending markets as a buffer to reduce risk. Bullish signals are more significant when the crossing of the MACD line over the signal line takes place below the zero line. The MACD can be used to identify periods when a security or index is either overbought or oversold. A divergence occurs when the trend of the price does not agree with that of the indicator.
The MACD Indicator: An Introduction to Momentum Trading
Introduction
Understanding the MACD and its usefulness in Forex and Stock trading
The structure of the MACD indicator and its default settings
Components of the MACD Indicator
The MACD Line
The Signal Line
The MACD Histogram
Calculating the MACD Line
Using the MACD Indicator in Trading
The Relationship between Two Moving Average Lines and the MACD
Using the MACD Line Relative to the Zero Line for Trading
Interpreting the MACD Histogram for Trading
Crossovers
Overbought/Oversold Conditions
Divergences
Using the MACD as a Lagging Indicator in Trending Markets
Using the MACD to Identify Overbought or Oversold Conditions
Determining Overbought or Oversold Conditions with the MACD
Using the MACD to Identify Divergences
Bullish Divergences
Bearish Divergences
Double Divergences
Trading MACD Divergence for an Edge in the Market
Conclusion: An Effective Tool for Momentum Traders
Introduction
Forex and stock trading can be complicated, but momentum indicators like the Moving Average Convergence Divergence (MACD) can make things easier. The MACD is an oscillator that uses moving averages as input to determine momentum. In this article, we will explore the MACD indicator and its default settings, its components and how to use them in trading.
Understanding the MACD and its usefulness in Forex and Stock trading
MACD stands for Moving Average Convergence Divergence, and it is a widely used indicator in forex and stock trading. The MACD indicator uses moving averages to determine momentum, making it a momentum indicator. Momentum indicators aim to identify the strength of a trend through the movement of trend lines. The MACD measures the difference between two exponential moving averages and turns them into a momentum oscillator.
The structure of the MACD indicator and its default settings
The MACD indicator consists of three elements – the MACD line, the Signal line, and the MACD histogram. The MACD line is the faster of the two and is more sensitive to price changes. The second line of the indicator is the Signal line, and it is slower than the MACD line. The MACD histogram represents the difference between the MACD line and the Signal line. The bigger the gap between the two lines, the higher the bars that the MACD histogram will display.
The default settings for the MACD indicator are 12, 26, and 9 for the faster, slower and Signal lines respectively. However, these settings can be adjusted to suit the trader’s requirements.
Components of the MACD Indicator
The MACD Line
The MACD line is the faster of the two lines on the MACD indicator. It reacts faster to price changes and is more sensitive. The MACD line can move above and below the Signal line, and the distance between the two lines indicates the strength of the market trend.
The Signal Line
The Signal line is the slower of the two lines on the MACD indicator. It gets frequently breached by the MACD line, and when it crosses above or below the MACD line, it creates trading signals.
The MACD Histogram
The MACD histogram represents the difference between the MACD line and the Signal line. When the two lines converge or move closer together, the histogram diminishes. On the other hand, when the two lines diverge or move farther apart, the histogram grows larger.
Calculating the MACD Line
The MACD line is calculated by taking the difference between a longer-period and shorter-period exponential moving average. Exponential moving averages are used because they respond more quickly to changes in price, with more weight placed on the most recent price compared to the earlier prices. Common periods used are 12-, 26-, and nine-period averages.
Using the MACD Indicator in Trading
To use the MACD indicator effectively, one needs to understand how it works. When plotted on a chart, the interaction between the two lines and their positions relative to the zero line are the most important aspects.
The Relationship between Two Moving Average Lines and the MACD
When the two moving averages used in the MACD indicator move away from each other, the MACD line rises or falls. When they cross, there is a corresponding crossing of the zero level by the MACD line. When the signal line and MACD line averages cross, there is a corresponding crossing of the zero level by the MACD histogram.
Using the MACD Line Relative to the Zero Line for Trading
When the MACD line is above the zero level, it indicates that the shorter-period moving average is above the longer-period moving average, indicating that the market is bullish. When the MACD line falls below the zero level, the shorter-period moving average is less than the longer-period moving average, indicating that demand is more bearish than it was in the past. If the fast line is above the slow line, MACD-histogram is positive and plotted above the zero line, suggesting a bullish bias.
Interpreting the MACD Histogram for Trading
Crossovers
Crossovers are the most popular use of MACDs. A sell signal is generated when the MACD crosses below the Signal line, and a buy signal is generated when the MACD crosses above the Signal line.
Overbought/Oversold Conditions
Determining if a security or index is either overbought or oversold is another use of MACDs. You may expect the price, after a significant upward trend, to fall and return to a more normal level. Using the MACD to identify periods when a security or index is overbought or oversold requires determining when the MACD line and the Signal line are below or above the zero line.
Divergences
MACD divergences preface a reversal in the current price trend. This happens when the trend of the price does not agree with the trend of the indicator. Bullish divergences occur when a price records a lower low, and the MACD forms a higher low. Bearish divergences occur when the MACD is making new highs while prices fail to reach new highs.
Using the MACD as a Lagging Indicator in Trending Markets
Like moving averages, MACDs are lagging indicators. They work best in strong trending markets, keeping you on the “right” side of the market, meaning you buy and sell late. The MACD can be used as a buffer to reduce risk, not as the main signal.
Using the MACD to Identify Overbought or Oversold Conditions
When the MACD rises significantly, overbought conditions may exist, when the price has experienced an upward trend. Oversold conditions may exist when the price has seen an extended downward trend. The best buy signals come when the MACD line and the Signal line are below zero line.
Using the MACD to Identify Divergences
To identify divergences, one can use the MACD histogram, the MACD line or the Signal line. Double divergences on the Histogram, Signal and MACD line are the most potent signals.
Trading MACD Divergence for an Edge in the Markets
Trading MACD divergence provides a real edge in the market when done correctly.
Conclusion: An Effective Tool for Momentum Traders
The Moving Average Convergence Divergence (MACD) is a widely used momentum indicator in forex and stock trading. Its components are the MACD Line, Signal line, and the MACD histogram. The MACD is a lagging indicator that aims to keep traders on the “right” side of the market (on the long side during uptrends and short side during downtrends). MACDs are best used in strong trending markets.
