Today we will talk about one of the most useful indicators in Forex. This is the well known Moving Average Convergence Divergence a.k.a MACD indicator. This tool has a lagging character. In other words, it is used to confirm trends, rather than to predict them and its signals come after the trend has actually occurred on the chart.
Moving Average Convergence Divergence Calculation
The MACD indicator consists of couple lines and a histogram. Traders often mistaken the two lines for regular Exponential Moving Averages. The truth, though, is different.
The default MACD parameters are 12, 26, 9. We will now show you the idea behind these values:
The faster line of the MACD indicator is also called a MACD Line. It is being calculated by finding the 12 EMA of the price action and then subtracting 26 EMA from it.
MACD Line = 12 EMA – 26 EMA
The slower line of the MACD is called Signal Line. This is so, because the MACD Line goes above and below this line, creating signals. The Signal Line is being calculated by plotting a 9-period Exponential Moving Average on the MACD Line.
Signal Line = 9 EMA on the MACD Line
Moving Average Convergence Divergence Signals
Forex traders identify three basic signals when trading with the MACD. For this reason, we will now go through each of these:
The crossover is the situation when the MACD Line breaks the Signal Line upwards or downwards. In this manner, the MACD crossovers create a signal in the direction of the cross. If the MACD Line breaks the Signal Line upwards, we get a bullish signal. If the MACD Line breaks the Signal Line downwards, we get a bearish signal on the chart.
The MACD divergence acts the same way as other trading indicators. When price is increasing and the MACD is creating lower tops and bottoms, then you have a bearish divergence between the price action and the MACD. When price is decreasing and the MACD is creating higher tops and bottoms, then you get a bullish divergence on the chart.
As you probably know, bullish divergences signalize for a strong bullish potential. Contrary to that, bearish divergences imply that the price might drop rapidly.
Although many people do not know about this function of the MACD, it is there for you. Indeed! The MACD could really give overbought and oversold signals, like an oscillator. But how does the Moving Average Convergence Divergence does this? Here it is:
MACD Overbought Signal
You get an overbought MACD signal when the MACD line rapidly gains big bullish distance from the Signal Line. In this manner, the MACD histogram will give you a relatively big bullish bar. When the indicator signalizes that the Forex pair is overbought, the pair is likely to start a decrease.
MACD Oversold Signal
This acts the exact opposite way as the overbought signal. You have an oversold MACD signal when the MACD line suddenly gains big bearish distance from the Signal Line. In this case the MACD histogram is likely to show a big bearish bar. When the Moving Average Convergence Divergence is oversold, the following price action is likely be bullish.
MACD Trading Examples
We will now demonstrate you a real Forex case, which includes separate MACD signals on the chart. Have a look at the image below:
The red marks on the image illustrate couple down runs of the EUR/USD the MACD has notified us for.
You should try going short when the MACD lines cross downwards. You should stay in the trades until the MACD lines cross in the other direction.
The same is in force for bullish crossovers of the MACD lines. When the two lines cross upwards, you should buy the Forex pair. You should hold the long trade until the two lines cross downwards.
The blue marks on the image illustrate an overbought MACD conditions, which lead to a rapid price drop.
Let’s now approach a divergence at the Moving Average Convergence Divergence indicator.
The blue lines on the image indicate that the price accounts for higher highs. At the same time, the Moving Average Convergence Divergence signalizes for lower highs. This creates a bearish divergence between price action and MACD. As a result of that the price then drops with a relative strength.
Click on the button below and start right away!