Trading with MACD explained by professional Forex trading experts the “Trading with MACD” FX trading team.
Trading with MACD?
The Moving Average Convergence/Divergence indicator, often called just ‘MACD,’ is usually one of the first learned by new traders, and in many cases – this is one of the first oscillators that traders will apply to their chart.
Unfortunately, MACD does not work all the time (which is something that can be said about every indicator based on past price information); and as such many new traders will often eschew MACD after noticing that not every signal would have worked out productively.
In this two-part series, we’re going to look at how MACD is constructed, as well as an additional input setting that may allow traders to take better advantage of the indicator; we’ll then move on to look at 3 specific strategies that traders can look to use with MACD in our next article, Three Simple Strategies for MACD.
What Makes up MACD?
MACD is a very logical indicator, and it does just what the name describes: It measures the spatial relationship of 2 Exponential Moving Averages.
The most common default inputs for MACD are using EMA’s of 12, and 26 periods – along with the ‘signal’ line of 9 periods. For now – let’s just focus on the MACD line itself, which is simply the difference between the 12, and 26 period EMA (using default inputs).
In down-trending markets, the fast moving average will move down faster than the slow moving average. As the fast moving average ‘diverges’ from the slow moving average, MACD will illustrate that relationship. And in up-trending markets, the 12 Period EMA should move up faster than the 26 Period EMA. As such, MACD will move higher to express this growing difference between the 12 and 26 Periods’ Moving Average. The graphic below will illustrate this relationship, with the 12 and 26 period EMAs applied on the chart along with MACD using 12, and 26 periods
Notice that MACD helped traders notice the trend change from a very early stage, as the blue boxes above began before the downtrend was completely finished.
This is a key part of the indicator, and something we will delve much deeper into with our next article on 3 MACD strategies: Using MACD as a ‘trigger’ into trades. But before we get to that, you probably noticed the ‘0’ line drawn on the MACD indicator in the above chart. This is a key part of the indicator, as it shows us when there is no difference between the EMA’s.
The Signal Line
As we saw above, MACD can be helpful for noticing potential trend changes at the very early stages of a currency pair’s move.
However, if we wait for a ‘0 line crossover (MACD to cross the ‘0’ line), we are essentially trading a Moving Average Crossover – which is inherently lagging the market and may not be the optimal point of entry.
This is where the ‘Signal Line’ comes into play. The signal line is simply a moving average built on the value of the MACD line. By default, this value is commonly set at 9 periods.
Building on the relationship of the MACD line itself, traders will often look for entry opportunities when MACD crosses the signal line.
When the MACD line crosses ABOVE and OVER the signal line, it is looked at as a signal to BUY. When MACD crosses below the signal line, it is often looked at as a signal to SELL.
Trading with MACD Conclusion
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