MACD is a short form for Moving Average Convergence Divergence. The indicator is well-known within the trading community to be reliable and robust for novice and professional traders alike.
How The MACD Indicator Works
The MACD indicator is a widely used technical analysis tool that is made up of two lines within an area alongside a histogram.
The MACD indicator reveals the difference between the 26-period and 12-period Exponential Moving Averages.
The histogram displays a 9-period Exponential Moving Average that is plotted as an overlay.
The readings on the histograms are either negative or positive depending on whether it is aligned below or above the zero signal line respectively.
The MACD indicator is well captured as a lagging indicator, investors make use of it as a momentum indicator and also to spot market direction, as well as trend.
It does find use in determining when a trend is going to start, in addition to when it would end.
Traders have been able to evolve their own techniques that bothers around some personalized settings and methods in generating MACD trading signals.
Our main target as currency traders has always been to locate a trend, considering that is where the money is being made.
For the sake of clarity, the blue line depicts the MACD line, while the Signal Line is represented by the red line. The entire MACD setup is embodied using some simple calculations which are as follows:
Main Line: 12 EMA – 26 EMA
Signal Line: 9 EMA of Main Line
Histogram: Main Line – Signal Line
The image below shows us a vivid outlay of how the indicator get laid out on the activity chart:
Fig.1.0
Understanding Basic MACD Signals
There are a number of forex trading strategies that can be formulated using the MACD indicator:
MACD Crossing Signals
The crossing of the MACD trigger lines is one of the most crucial Moving Average Convergence Divergence signals, which offers us valid alerts as to whether a trend is heading in the direction of the cross.
There are many cross alerts that the MACD indicator dishes out, acting on each of them can be disastrous. If you must act, adhere to the following rules only:
- Bullish MACD Crossover – A bullish MACD crossover is in place when the MACD Line crosses the Signal Line to align above it. The bullish signal is binding if it occurs below the 0.00 level.
- Bearish MACD Crossover – Conversely, a bearish MACD crossover is said to occur when the MACD Line crosses the Signal Line to stay below it and such is binding if it occurs when above the 0.00 level.
We get a false positive Bullish MACD Crossover signal when the Signal Line intersects the MACD Line to hover above it (when both lines are below the 0.00 level).
A Bearish MACD Crossover false positive is said to occur above the 0.00 level, when the Signal Line intersects the MACD Line to stay below it (see Fig. 1.0).
There are a lot of useful MACD forex indicators available for both the Metatrader 4 and Metatrader 5 trading platform.
MACD Divergence Signals
The Divergence strategy is also well traded on the MACD indicator, this signal method takes advantage of pattern discrepancies, such that when price is surging and the MACD registers lower highs – a Bearish Divergence is said to be on the horizon.
A Bullish Divergence on the other hand sees price declining and the MACD registers higher lows.
MACD Convergence Signals
There’s also the MACD Convergence, another style to which traders can trade using the MACD indicator.
Howbeit, traders trust the MACD Divergence more, due to the fact that when price breakdowns and declines, it does so quicker and stronger.
This is actually a fact, since fear dominates the market during price collapse.
MACD Convergence occurs on the activity chart during price declines which is accompanied by lower lows or lower highs, but simultaneously the bars of the MACD histograms go higher to form higher lows or higher highs.
The rule states that, price will lastly alter its direction and will follow that of the MACD.
The MACD Convergence is tagged the end of downtrends i.e. you should stay away from initiating sell orders when you notice the MACD Convergence forming.
This implies price might reverse at any instance.
MACD Overbought & Oversold Signals
The Overbought/Oversold strategy is a tradable option on the MACD indicator, but a lot of traders are unaware of its powers, but to spot such zones on the indicator, you need to be on the lookout for wide gaps between the MACD Line and the Signal Line of the indicator.
Having an understanding that the MACD has no limits, a good look back at the security’s historical data will allow us gauge this more accurately.
Sequel to a bearish trend, an Overbought MACD is established when the MACD Line attains quite a wide gap from the Signal Line.
On the other hand, an Oversold MACD also displays a wide gap between the MACD Line and the Signal Line following a bullish trend.
MACD Histogram Signals
Trading in accordance to the MACD Histogram is something traders don’t really pay attention to.
This can be achieved when a histogram bar closes contrary to the overall histogram trend.
A buy signal is initiated when one histogram closes higher, while a sell alert is triggered when the reverse occurs i.e. when a histogram bar closes lower.
The first trade we have is a buy signal, followed by a sell signal and then a buy alert comes into play (see Fig. 1.1).
Fig. 1.1
How to Take Profits Using MACD
Many traders are faced with the problem of not knowing when to take profits or even how to go about it, especially when they’re riding the profits.
One way to validate your exits when using the MACD is to hold your orders until you get an opposite signal.
This means a conflicting MACD signal will be a nod to exit your position.
MACD Trading Strategies For Scalpers
Scalping is permissible when using strategies that are built around the MACD. It is a well-known fact that scalpers tend to liquidate their positions in quick successions that last not more than 5-minutes each.
To help you achieve this, the MACD indicator can be applied to smaller timeframes, where traders can adopt the crossover technique for opening buy/sell orders.
Above all, finding the right market environment is crucial for a successful scalping campaign.
Although, trading smaller time frames is a specialty for scalpers, there’s need to view price on multiple time frames in a bid to grasp the big picture.
The 1-Hour and 4-Hour charts are very significant and quite applicable on the MACD, but only just as a means of seeing what the long-term outlook spells.
Here is a simple scalping strategy that is designed around the MACD indicator.
MACD Trading Strategies For Day Traders
Day traders can absolutely deploy the MACD as a single indicator or in a mix with other technical tools depending on the time frame you are trading on.
One of the things you should pay attention to is the level of volatility an instrument displays.
If price volatility is high, there is fewer chances that the MACD or any other technical study will accurately predict price action.
We have explained some of the workings of MACD for day traders here.
MACD Trading Strategies For Swing Traders
Of course swing traders can incorporate the MACD indicator into their trading strategies, here’s an example of a swing trading MACD strategy.
Integrating the MACD into your trading strategy will translate into you being able to effectively trade within a specified channel, a feat that is possible by activating the MACD’s overbought/oversold characteristic.
In doing so, traders can further determine areas of support (oversold zones) and resistance (overbought zones).
Conclusion
Going against the MACD indicator might prove risky. The MACD indicator can save you from trading against the trend.
Considering the fact that the MACD is lagging, when you get a reversal signal on other indicators and/or candlesticks patterns, and you intend on taking a position against the trend, the MACD can issue out warnings that will halt you on your tracks.
Beginners are unable to differentiate the strong candlestick patterns, and developing your trading strategies around the MACD provides you the leverage of not going against the trend in relation to confusing candlestick patterns.
Asides the mistake of going against the trend, the MACD indicator as we have earlier indicated above, can disclose when the market is overbought or oversold.
It thus implies that traders should avoid going long when the market is overbought, and taking short positions when the market is oversold.
It is a known fact that when the market is overbought, it is dicey to go long and when it is oversold, it is unsafe to initiate sell triggers.
Bulls are known to collect their profits (they sell) during overbought condition, hence price tends to decline, and when the market is oversold, Bears are believed to take profits as well (they buy), as such price tends to appreciate.
We are aware that other technical tools like candlestick patterns can tell us if the market is overbought or oversold, but the MACD is obviously a big aid.
It is okay to be aware of the pitfalls associated with using the MACD indicator in isolation, one of which is its lagging characteristic, which is not much of a problem if the indicator is well combined with the right mix of technical tools.