What is the MACD Indicator

What is the MACD Indicator

Submitted by adil on Mon, 02/17/2014 - 06:05

The Moving Average Convergence Divergence commonly known as MACD is the most widely used indicator in the financial markets. This indicator can help day traders to take considerable amount of profits from their trades. However, most of the new traders start using this indicator without understanding how to make calculations with the help of it or how it functions. This negligence can lead to drastic losses and therefore, traders should try to avoid it at any cost. If you want to configure your day trading more accurately, it is advisable that you understand the calculations and logic behind MACD in order to take profits on regular basis.

MACD Defined:

Anyone associated with financial markets especially with Forex would definitely have heard a lot about MACD. In fact, it is very important to understand how it works otherwise you will not be able to identify the emerging trading signals and use them in your favor. In simplest words, “the MACD is a momentum indicator that is designed to follow existing trends and find new ones.” The MACD accomplishes this task by displaying the relationship and difference between price activity and a two level combination of moving averages.

MACD Calculations:

A trader needs to subtract a 26 period Exponential Moving Average (EMA) from 12 period EMA. Subsequently, he has to plot a 9 period EMA which eventually becomes the indicator’s signal line. This signal line is used as a trigger reading for trading signals (both sell and buy signals) and it is plotted over the MACD. It is imperative for any trader to understand all these elements thoroughly as they form the fundamental units of Moving Averages Convergence Divergence. If you fail to grasp these terms effectively, it will become quite difficult for you to use MACD successfully in your daily trading.

Three Common Approaches:

Different traders use MACD differently but there three approaches that are most popular. It is also important for traders to figure out how different traders use MACD. It will not only help them to use it more profitably but will also assist them in countering the tactics of their rivals. In this regard, three of the most common methods to use MACD are given as under.

• Crossovers:

In this particular strategy, the crossing point of two moving averages is used to determine the entry and exit points. In this case, a period 50 simple moving average (SMA) as well as a period 10 exponential moving average (EMA) is applied to close. The 4 hours’ time period has proved to be most effective but traders can use longer time periods as well.

• Divergence:

Divergence is actually the simplest of all the methods to use MACD. In this case, the security price signals the end of the trade if it diverges from the MACD.

• Dramatic Rise:

Sometimes the MACD also rises dramatically. In this case, shorter moving average will dramatically move away from the long term moving average. This condition indicates that the security is overbought and will return to the normal very soon.

Traders also monitor the movement of short term average relative to the long term average by watching the movement below or above zero line. The short term average signals the upward momentum as it is above the long term average and vice versa.

It is a great idea to deeply understand these approaches as MACD has become the most important indicator in Forex industry. For that matter, you also have to grasp its basics and failure in this regard can result in massive losses for new traders.