MACD stands for Moving Average Convergence Divergence. It is a market trend-following oscillator that signals which market is dominating and whether it is getting stronger or weaker. Traders use it to confirm who is in control of the market and to locate entry and exit points on their trades.
It is made up of two lines: the MACD line and the signal line.
The first shows the result of subtracting two exponential moving averages (usually those of 26 and 12 or 14 and 28 periods). The second is an exponential moving average (usually 9 periods) of the previous one. Both oscillate on a 0 axis, giving rise to positive or negative values.
When the MACD line is above the signal, the general market sentiment is bullish. If the signal is the one above, the market is in bearish sentiment. The usual thing is that both move in parallel keeping a small distance between them.
Additionally, it is possible to represent a vertical bar chart called a MACD histogram. Like lines, it can appear above the 0-axis showing positive values or below it with negative values. The former indicates a bull market and the latter a bear market.
How is the MACD Calculated?
Broadly speaking, this indicator is formed by drawing a line that corresponds to the difference between two moving averages and calculating a moving average from it.
MACD Line = Fast Exponential Moving Average (12 or 14 periods) – Slow Exponential Moving Average (26 or 28 periods)
Signal = Exponential moving average of the MACD line
Histogram = MACD Line – Signal
If it seems complicated to you, do not worry in the least because you will not have to calculate it yourself. Almost all Forex trading platforms today do this automatically. All you need is to choose the MACD indicator from a list and add it to the chart you are analyzing.
The MACD histogram shows the separation between both lines in a clearer way.
It is formed by vertical bars that are born from axis 0
If the MACD line is above the signal, the histogram remains positive. Otherwise, it shows negative values
Positive values indicate that buyers are stronger and the market is bullish
Negative values show that the market is dominated by sellers and is bearish
The bars are the same size when both lines stay parallel
Rising bars indicate that MACD is breaking away from the signal
Decreasing bars warn that MACD is approaching the signal
On some platforms the histogram is optional and not displayed by default, you will have to enable it in the indicator settings
How to use the MACD?
To start using this trading indicator, add it to the price chart you are analyzing. Then, use your readings to interpret what is happening in the market.
Reading the MACD
By analyzing the MACD indicator it is possible to find the following readings:
Uptrend (bullish): The MACD line is above the signal. The histogram shows that the bars are above the 0 levels. It indicates that buyers are the dominant force in the market and confirms that the price-led uptrend is in good health.
Bearish trend: The MACD line is below the signal. It is also seen in the histogram when the bars are below the 0 axes. If the price is showing a downtrend, the indicator confirms it.
Trend change from bullish to bearish: If the MACD line crosses the signal to the downside, the uptrend could end and the price starts to go down. This cross can be taken as a warning to enter the market shortly or to close long positions.
Trend change from bearish to bullish: When the MACD line crosses the signal to the upside, the current bearish trend could end and give way to a new uptrend. Many Forex traders use this event to enter the market long or to close trades short.
Price in the overbought zone: An asset is overbought when the buying force has been abnormally high for a while. Interest could fade at any moment and the current uptrend change to down. The Forex MACD indicator shows it when the histogram bars are above 0 and getting longer. Also when the MACD line is above the signal and it separates sharply instead of continuing parallel. Can be used as a short entry signal or to close long positions
Price in the oversold zone: When the market has been under strong selling pressure, it is said to be oversold. It is possible that the ongoing downtrend will stop and the price will start to rise. The MACD histogram shows bars with values below 0 and their size is getting bigger. It can be seen on the lines when the MACD is below the signal and breaks away from it instead of staying parallel. It is a good signal to enter buying or to close short positions
Divergences: They occur when the trend marked by the MACD does not correspond to the behaviour of the price. For example, the indicator shows bullish strength, but the price remains sideways or down. They indicate that the behaviour of the market could be about to change and it is necessary to proceed with caution. Divergences in trading are often used as a filter to rule out trades
Set up the MACD Indicator for Trading
Before you start using this indicator for Forex trading, it is important to know how to set it up.
The MACD allows you to adjust 3 parameters: the number of periods of the two moving averages that are used to draw the MACD line and the number of periods of the moving average that will be used for the signal.
A configuration used by many traders and accepted as standard is the following:
Slow moving average of the MACD line: exponential, 26 periods
Fast moving average of the MACD line: exponential, 12 periods
The moving average for the signal: exponential, 9 periods
Others prefer to use 28, 14 and 9 respectively. Note that these values might work well in some cases, but it is best to set the indicator individually for each Forex chart. This is achieved through backtesting.
Backtesting consists of applying a configuration to the indicator and observing how it would have behaved in the past. It starts from some initial parameters (they can be the ones indicated above) and they are adjusted so that their signals coincide with the correct entry and exit points.
For the backtesting configuration to be effective, you have to do it for the asset and time frame in which you are going to operate. Using the parameters you got in another graph can be counterproductive.
This way of setting up the MACD increases your chances of success, but keep in mind that there is no guarantee that the market will behave the same way in the future as it did in the past.