MACD (Moving Average Convergence/Divergence)

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The MACD (Moving Average Convergence/Divergence) is a momentum indicator used to show the relationship between two moving averages. The MACD was developed by Systems and Forecasts publisher, Gerald Appel.
The MACD is simple and reliable. It uses moving averages to include trend-following characteristics. These lagging indicators are turned into a momentum oscillator and plotted as a line that moves above and below zero with no upper or lower limits.

The MACD proves most effective in studying wide-swinging trading markets.MACD (2-lines) shows the relationship between a 26-day and 12-day Exponential Moving Average with a 9-day Exponential Moving Average (the "signal" or "trigger") line plotted on top to show buy/sell opportunities.Three popular ways to use the MACD are crossovers, overbought/oversold conditions and divergences.
- Crossovers:
The basic MACD trading rule is sell when the MACD falls below its signal line and buy when the MACD rises above it. It is also common to buy/sell when the MACD goes above/below zero.
- Overbought/Oversold Conditions:
The MACD is also can be used as an overbought/oversold indicator. If the shorter moving average pulls away dramatically from the longer moving average and the MACD rises it is likely that the security price is overextended and will soon return to more realistic levels.
- Divergences:
Expect the end a current trend may be near when the MACD diverges from the price of a security. A bearish divergence occurs when the MACD is making new lows while prices fail to match these lows. Likewise, a bullish divergence occurs when the MACD is making new highs while prices fail to follow suit. Both of these divergences are most significant when they occur at relatively overbought/oversold levels.
MACD Histogram
Signals from the MACD Indicator can tend to lag behind price movements. The MACD Histogram is an attempt to address this situation showing the divergence between the MACD and its reference line (the 9-day Exponential Moving Average) by normalizing the reference line to zero. As a result, the histogram signals can show trend changes well in advance of the normal MACD signal.A buy signal is generated as the histogram crosses above the zero point. A sell signal is generated as the histogram crosses below zero.

MACD is an acronym for Moving Average Convergence Divergence. This tool is used to identify moving averages that are indicating a new trend, whether it’s bullish or bearish. After all, our [You must be registered and logged in to see this link.] priority in trading is being able to find a trend, because that is where the most money is made.
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With an MACD chart, you will usually see three numbers that are used for its settings.The first is the number of periods that is used to calculate the faster moving average.The second is the number of periods that are used in the slower moving average.And the third is the number of bars that is used to calculate the moving average of the difference between the faster and slower moving averages.

For example, if you were to see “12,26,9” as the MACD parameters (which is usually the default setting for most charting packages), this is how you would interpret it:

• The 12 represents the previous 12 bars of the faster moving average.
  
• The 26 represents the previous 26 bars of the slower moving average.
  
• The 9 represents the previous 9 bars of the difference between the two moving averages. This is plotted by vertical lines called a histogram (The blue lines in the chart above).
  

There is a common misconception when it comes to the lines of the MACD. The two lines that are drawn are NOT moving averages of the price. Instead, they are the moving averages of the DIFFERENCE between two moving averages.In our example above, the faster moving average is the moving average of the difference
between the 12 and 26 period moving averages. The slower moving average plots the average of the previous MACD line. Once again, from our example above, this would be a 9 period moving average.

This means that we are taking the average of the last 9 periods of the faster MACD line, and plotting it as our “slower” moving average. What this does is it smoothes out the original line even more, which gives us a more accurate line.

The histogram simply plots the difference between the fast and slow moving average. If you look at our original chart, you can see that as the two moving averages separate, the histogram gets bigger. This is called divergence, because the faster moving average is “diverging” or moving away from the slower moving average.

As the moving averages get closer to each other, the histogram gets smaller. This is called convergence because the faster moving average is “converging” or getting closer to the slower moving average. And that, my friend, is how you get the name, Moving Average Convergence Divergence! Whew, we need to crack our knuckles after that one!

Because there are two moving averages with different “speeds”, the faster one will obviously be quicker to react to price movement than the slower one. When a new trend occurs, the fast line will react first and eventually cross the slower line. When this “crossover” occurs, and the fast line starts to “diverge” or move away from the slower line, it often indicates that a new trend has formed.
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From the chart above, you can see that the fast line crossed under the slow line and correctly identified a new downtrend. Notice that when the lines crossed, the histogram temporarily disappears. This is because the
difference between the lines at the time of the cross is 0. As the downtrend begins and the fast line diverges away from the slow line, the histogram gets bigger, which is good indication of a strong trend.There is one drawback to MACD. Naturally, moving averages tend to lag behind price. After all, it's just an average of historical prices. Since the MACD represents moving averages of other moving averages and is smoothed out by another moving average, you can imagine that there is quite a bit of lag. However, it is still one of the most favored tools by many traders.

Moving Average Convergence/Divergence (MACD) is one of the simplest and most reliable indicators on Forex. With MACD you’ll be able to spot bull divergences and bear divergences which are rare and effective patterns on Forex.

Bullish Divergence
When the price reaches a new low, and MACD can’t reach a new low, there’s a bullish divergence which shows that the downtrend is losing steam and an uptrend might be near. Here is an example:
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In this chart you can see an example similar to one I showed you when I talked about RSI. The price was at the same point as on the previous bottom, while MACD was at an higher point.
After this bullish divergence, EUR/USD started an uptrend of more than 1200 pips.

Bearish Divergences
When the price reaches a new high, and MACD can’t reach a new high, there’s a bearish divergence which shows that the uptrend is losing steam and a downtrend might be near. Here are some examples:
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On this chart the EUR/USD reached a new high while MACD is below the level it achieved on the previous top. This is a clear bearish divergence.
This bearish divergence resulted in a strong downtrend of more than 700 pips.
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Here is another bearish divergence. There’s a new high on EUR/USD and MACD is at a lower level. As a result, EUR/USD started a nice downtrend that lasted for 2 months.
MACD is not particularly good identifying overbought and oversold levels. Even though it is possible to identify levels that historically represent overbought and oversold levels, MACD doesn’t have any upper or lower limits to bind its movement. MACD can continue to overextend beyond historical extremes.

Confirmation Indicator
You can also use MACD as a confirmation indicator.
If MACD Histogram is above 0 this means we’re in an uptrend. If MACD Histogram is below 0, we’re in a downtrend.
Using a cross above 0 or below 0 as a buy or sell signal respectively, works well during strong trends, but when the market is choppy, this technique gives too much false signals. So, I only recommend using MACD histogram above 0 or below 0 as a confirmation of other indicators buy and sell signals.
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In this chart you can see that a cross above 0 signaled a strong trend that lasted 4 months and caught more than 700 pips profit. This kind of signal works well during strong trends.
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Unfortunately, during choppy markets, MACD gives too much false signals as you can see on the above chart. That’s why I just use MACD to spot divergences and to confirm trades. That’s the best way to use MACD on any kind of market.