Definition:

The Moving Average Convergence/Divergence or MACD indicator is one of the simplest and most reliable momentum indicators available and was initially developed by Gerald Appel. The MACD provides technical analysts with a useful way to determine whether a trend exists, how strong it is, in what direction it is moving and whether it may soon be reversing.

The MACD indicator basically computes the difference between two moving averages of the market price and is often plotted as a histogram of these differences for each time period. The MACD oscillates above and below the zero line and does not have any absolute limits on its value. It can be applied to charts of any time frame.

Typically, traders will use a 26-period and a 12-period Exponential Moving Average or EMA to obtain the classic version of the MACD indicator initially recommended by Appel. Nevertheless, the lengths of the moving averages can be varied to better fit a particular currency pair.

In addition, a Trigger Line will generally be computed and plotted over the MACD indicator that can generate signals to help a trader identify additional trading opportunities.

Sample Chart:

Usage:

Traders generally receive the best signals from the MACD indicator when the market trends clearly without trading conditions becoming too choppy. Often, they will look for confirmation from another trading signal before entering a position based on a MACD-based signal.

When observing the MACD indicator in practice, traders typically look for crossovers and the indicator’s divergence relative to the price. They can also use the indicator to identify overbought or oversold market conditions ripe for reversals.

Crossovers
One type of crossover on the MACD occurs when the indicator crosses above or below the zero line. When trading such MACD crossovers, the basic rule consists of selling when the indicator falls below zero or buying when it rises above zero. A crossover signal variation involves buying when the MACD moves above its trigger line, or selling when the MACD indicator falls below the trigger line.

Divergence
Divergence happens when extremes in the level of the MACD indicator diverge from those seen in the exchange rate. Divergence often presents a good clue that a market may be nearing a reversal point and it tends to have the greatest importance when occurring at an overbought or oversold price level.

Bullish or positive divergence means the MACD makes higher lows when the price is still making lower lows in a down trend. This indicates that the market may be about to reverse to the upside.

Conversely, bearish or negative divergence occurs when the MACD makes lower highs when prices continue to make higher highs in an upwards trend. This gives a signal that the market may be ready to reverse and trade downwards.

Identifying Overbought and Oversold Market Conditions
The MACD can also be used to indicate when the market is overbought or oversold. The idea behind this is that when the shorter-term MACD moving average separates or diverges strongly from the longer-term MACD moving average, it indicates an over-extended market.

When this situation arises that is characterized by a large absolute value for the MACD indicator, the market probably needs to correct or consolidate before continuing the trend. The market may even reverse direction altogether.

Calculation Method:

Technical analysts using the MACD typically calculate its value by subtracting a 26-period exponential moving average’s value from that of a 12-period exponential moving average. They will also compute a Trigger line that consists of taking a 9-period simple moving average of the MACD. This line will then be graphed over the MACD.

Define:

• n= the number of the time period bar in question.
• Close(n)= The closing price seen during time period n.
• SMA(A,B)= Simple Moving Average of data item A over B periods.
• EMA(A,B)= Exponential Moving Average of data item A over B periods.
• SIGNAL= The MACD’s trigger line.

Calculate:

• MACD(n) = EMA(Close(n), 12) - EMA(Close(n), 26)
• SIGNAL(n) = SMA(MACD(n), 9)

Practice MACD Trading

Technical analysis with MACD is a demanding skill that requires practice to master. We recommend that you use a demo account to train yourself for free before applying your skills to real money trading.
Most reputale trading platforms today (for example: GFC Trader, AVA Trader, Meta Trader) feature technical indicator functions which can be applied on real-time charts. You can open a free account, download the trading software and start sharpening your technical analysis skills today!

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