MACD - what you need to know.

They call it the MACD, or the Moving Average Convergence Divergence indicator.

But, I can hear you shouting “what the heck does that mean”
And more importanty, “how the heck is it usefull”

Ok, enough of the profanities! Lets get down to business.

Macd is probably the most popular price oscillator among traders.

In reality, it is pretty simple,

but people often complicate the simple things in life!

 

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In this article I am going to do three things for you.

1. Break down MACD to its simple core. (you will understand it better than a finance graduate after this!)
2. Show you how to get real meaning from the indicator.
3. Show you how to apply it to your trading, to hopefully boost your profitability.

 

The Histogram, Signal line and macd line, explained:

 

 

The MACD chart indicator is made up of three parts, the macd line, the signal line and the macd histogram.

• The MACD line is made by getting the 12 day EMA (exponential moving average) and the 26 day EMA and then subtracting them. (12-day EMA - 26-day EMA)
• The Signal Line is simply the 9 day EMA of the MACD (9-day EMA of MACD)
• And the MACD Histogram is the difference between the two! ( MACD - Signal Line )

Plot them around a zero line, Lump them onto a chart and there you go, Simple eh?!?

 

The MACD line:

 

 

The M A C D line tells you the difference between a short term average price ( 12 days ) and the longer term average price ( 26 days ).

Positive divergence:

If the price begins to move up, then the short term average will move up quicker than the longer term average thereby pulling the macd line to the positive side of the zero line.

Negative divergence:

If the price begins to move down, then the short term average will move down quicker than the longer term average thereby pulling the M A C D line to the negative side of the zero line.

And that is how the MACD line oscillates around the zero line.

 

MACD, Convergence and Divergence:

Simply put,

Convergence happens when the moving averages start to move towards each other, and
Divergence happens when the moving averages start to move away apart.

Think about it for a short while, there are two moving averages used in the indicator, a short term average, 12 periods, and long term average set at 26 periods.

If the price is in a down trend then both averages will be following the price down.

Then the price turns up,

This trend change will have a faster effect on the short term average, and so the shorter average will diverge from the longer average.

The same is true in the opposite direction.

And that is where we get moving average divergences from.

Centre line crossover:

The MACD Line oscillates around the centre line. When a crossover happens it means that the 12-day EMA has crossed the 26-day EMA.
A positive MACD line means that the 12-day EMA is above the 26-day EMA. And as the line rises it means upside momentum is increasing.
A negative M A C D line means that the 12-day EMA is below the 26-day EMA and as the line drops further it means downside momentum is getting stronger.

 

MACD strategy: how to us it in your trading.

 

The SIGNAL line crossover:

The signal line crossover is the one of the main trading signals.
The trading signal is generated when the signal line is crossed by the MCAD, and not the other way around !

As the signal line is a moving average of the Line, it will lag the MACD line.
The Bullish crossover happens when the M A C D turns up and crosses above the signal line.
The Bearish crossover happens when the M A C D turns down and crosses below the signal line.

 

 

 The CENTRELINE crossover:

A centerline crossover is the next trading signal.

A bullish centerline crossover: occurs when the MACD Line moves above the zero line to turn positive.
As you can see in the chart above, the bullish signal in the EURUSD came in at 11000 and led to a 650 point rise, to top out at 11650 in a very short period of time.

A bearish centerline crossover: occurs when the MACD moves below the zero line to turn negative.
The MACD will remain negative when there is a sustained downtrend.
The bearish signal in the chart occured at 11100 and EURUSD continued downward to 10750, that is a nice 350 point move.

Divergences:

Divergences happen when the MACD changes direction before the price turns.
There are two types, a bullish divergence and a bearish divergence.

A bullish divergence: forms when price drops to a lower low and the M A C D rises to a higher low. This divergence says that the downward momentum is waning and price is likely to turn up soon.

A bearish divergence: forms when price rises to a higher high and the M A C D drops to a lower high. This divergence says that the upward momentum is petering out and price is likely to turn down soon.

 

When to be conservative and aggressive!

 

The MACD histogram simply charts the separation distance between the M A C D line and the signal line.

It is a measure of the power of a price move and therefore can tell us how aggressive or conservative we should be.

Here's the tips:

Aggressively bullish: as the histogram rises away from the centreline the upward momentum is rising and the market is getting more bullish.

Conservatively bullish: As the histogram starts to approach the centreline again the upward momentum is dampening and the market is about to turn down.

Aggressively bearish: as the histogram falls away from the centreline the downward momentum is increasing and the market is getting more bearish.

Conservatively bearish: As the histogram starts to rise to the centreline again the downward momentum is stalling and the market is about to turn up again.

These pointers can be a guide as to how to position ourselves while trading.

For a more in-depth look into trading with the MACD, check out FOREX TODAY YouTube channel, they have done a great video on understanding M A C D.

 

What you need to know:

 

These are the main things you need to takeaway from this article.

The SIGNAL line crossover:

Generated when the signal line is crossed by the MCAD, an upward cross is bullish and a downward cross is bearish.

Centreline crossover:

Generated when the MACD line crosses the centreline of the indicator, a bullish signal is when line crosses up over, and a bearish signal is when the line crosses down below.

Divergences:

A bullish divergence: when price drops to a lower low but the MACD rises to a higher low.

A bearish divergence: when price rises to a higher high and the MACD drops to a lower high.

 

That is it in a nutshell, It wasn't too painful now was it!

I recommend using the MACD as part of your Quivver of trading indicators, stick to the basics and don't over complicate it.
The indicators are not the truth in and of themselves.
But they are a valuable signpost to the truth!

This knowledge, if applied correctly, will definitely push you towards better trading decisions and that is the name of the game!