The MACD is one of the most technical indicator when it comes to technical analysis of the Forex markets. The indicator is used by professionals to give even give sell and buy signals due to its accuracy in indicating market changes.
It is used to analyze the market trend, the strength of the trend (momentum) and the duration of the trend.
What is MACD?
The MACD, which is an acronym of Moving Average Convergence Divergence, is a momentum indicator which also follows the trend of the market. It is obtained from the Exponential Moving Average (EMA).
The indicator has three major components the MACD line, the signal line and the MACD histogram. In most cases the MACD histogram is forgotten and traders tend to only focus on the two lines (the MACD line and the Signal line), but the histogram is very important also as we shall see.
The plotted MACD line is usually the difference between an EMA with a period of 26 and an EMA with a period of 12. The period in this case is the number of days.
The other line which is plotted against the MACD is the one that is referred to as the signal line. This line is usually a Smooth Moving Average (SMA) of a period of 9 days. This line is very important since it is the basis of the trading signals; without it there will be no trading signals given.
To differentiate the MACD line and the signal line, the trader should set the lines with two distinct colors on the parameter customization menu. However, the MACD is always faster than the signal line.
The trader also has the liberty to change the periods of all the moving Averages involved. However, he/she should try to maintain the differences in the period even when changing them. The SMA responsible for the signal line should always have a lower period than the other two EMAs. Also, since the 26 and 12 EMAs are used for calculating the difference, the EMA with the period of 26 should always have a higher period than the one with the period of 12 to ensure a correct MACD line is plotted.
If you lower the periods, the lines will respond faster to market changes but they may end up becoming over responsive in that it exaggerates very small market changes. Again, if you make the period too large, the lines will drag themselves very much and may not respond to minor price changes. Therefore, you better leave the parameters as they are or if you are to change, you ensure you dot make them too small or too large.
The MACD indicator will also come with a MACD histogram that oscillates about the centerline on the indicators chart. This histogram shows the difference between the MACD line and the signal line.
Since the MACD uses the EMAs, it inherits the lagging of the EMAs. Therefore, the MACD is best used on those currency pairs which trend.
Interpreting the signals given by the three components of the MACD
The first this is the two plotted lines (the MACD line and the signal line). When the MACD line moves below the signal line, it indicates that there is a bearish trend. On the other hand, when the MACD line is above the signal line, it indicates there is a bullish trend.
The histogram shows the momentum of the trend and the direction of the momentum. The longer the bars of the histogram the more the momentum indicated. Also, if the histogram is on the upper side of the zero line, then the momentum is bullish. But when the histogram is on the lower side of the zero line, then the momentum is bearish.
When to place a buy and sell order
- Buy order
A buy order should be placed when the MACD line is above the signal line. The trader should also check to see that the crossing of the two lines happened below the zero line and that the MACD histogram is on the upper side of the zero line.
When the MACD line is above the signal line, it shows that the trend is bullish. When the histogram is above the zero line it shows that the momentum of the current trend is bullish. Therefore there is a ‘strong’ bullish trend.
- Sell order
A sell order should be placed when the signal line is above the MACD line. Similarly, the trader should also check to see that the crossing of the two lines happened above the zero line and that the MACD histogram is below the zero line.
When the Signal line is above the MACD line, it shows that the trend is bearish. When the histogram is below the zero line it shows that the momentum of the current trend is bearish. Thus there is a ‘strong’ bearish trend.