FxBrokerReviews.org – Trading requires in-depth analysis. To ensure that you can book your profits on investments it is crucial to know about the movement and changes in the market. Understanding how the market works takes a lot of reading and research especially if you are a new trader. Therefore, to smooth out the trading process various technical tools and chartings have been introduced to help you understand the market’s movement.
One such indicator that is loved by all traders is the MACD indicator. I’m sure you might have heard about it. But not sure how to use it? Let us understand what is a Macd indicator, how it works, and how can it be helpful to you.
What is Macd indicator?
Macd indicator is the short form for the Moving Average Convergence Divergence indicator. MACD is a popular momentum indicator, developed by Gerald Appel. The indicator is mostly used to trade in the stock market and provides data on the moving averages. It helps analysts and traders to reveal changes in the momentum, trends, and direction of the trade.
A Macd indicator shows the relationship between two moving averages of a security’s price. Moreover, it helps the investors to understand whether there is a bullish or bearish movement and if the price is strengthening or weakening. Primarily, the indicator consists of three main parts components that help you in your analysis. Here is how to understand the macd indicator and it’s working!
Understand how the Macd indicator works
If you look at a MACD chart you will find three numbers that are used
- The first number that you see is used to calculate the faster-moving average.
- The second is the number of periods used in the slower moving average.
- And the third is the number of bars that are used to calculate the difference between the faster and slower moving averages
Let us understand with an example :
You will find numbers 12, 26, and 9 on the chart, these numbers are the default Macd parameters set for the software, this is how you can understand the meaning :
- 12 represents the moving average of the previous 12 bars.
- 26 shows the moving average of the previous 26 bars.
- And 9 shows the moving average of the difference between the two averages above.
Now let us understand the lines that are visible on the Macd indicator :
- Macd line: the Macd line is the most integral part of the indicator. It is the difference between two moving averages. These two moving averages are known as exponential moving averages (EMAs). Taking the above-mentioned example: The MACD line is the difference between the 12 and 26-period EMA.
- Macd signal: the signal line is known as the slower moving average and indicates the 9-period EMA of the MACD Line.
- Macd histogram: the histogram is just a graphical representation of the difference between the two moving averages i.e. the Macd line and the signal line. It is useful as it gives signs if there is a chance of an early macd crossover.
These components altogether make up the macd indicator
Also read: What Are Candlesticks in Forex?
How does the Macd indicator work?
The MACD is a momentum indicator and you can use it to predict the various trends, momentum, and changes in the stock prices. Let us take a deeper look at how the macd indicator works :
The working of the indicator depends on the movement of the two lines. if the two moving averages i.e the Macd line and the signal appear to come together, then they are known to be ‘converging’ whereas if they move away from each other they are said to be ‘diverging’. If the MACD is trading above the line of zero it is considered an uptrend, and if it is trading below then it would be considered a downtrend.
In addition to this, the indicator also signals traders to buy or sell orders. This can be identified when the two MACD lines cross over. When the MACD line crosses above the signal line, it indicates BUY. Whereas when the MACD crossover happens below the signal line, it is a sign for the traders to SELL.
Also read: How Do I Trade Forex?
How to read Macd – The moving average convergence divergence indicator?
These points will help you read the indicator better as well as analyze your trades better. Read below to find out how to use the macd indicator effectively:
- When MACD crosses above zero it is considered bullish. But when it is below zero it is bearish.
- When the MACD line crosses from below to above the signal line, the indicator is said to be bullish and when the line crosses from above to below the signal line it is bearish.
- The Macd crossovers with the signal line are the main indicators.
- When there is a crossover with the signal line, the MACD line rises faster than the signal line and crosses it from below.
- If the MACD line crosses it from above and falls faster than the signal line, then it is an indication of price losses.
- But in case both the lines are moving in the same direction, it is known as convergence, and this confirms a movement in price.
- Similarly, If the lines move in an opposite direction, the pattern that is formed is known as divergence.
- Sometimes due to low market volatility, the price range of the stocks gets tight and small which causes the histogram to squeeze. Your histogram should look flat when you start trading.
How to calculate MACD?
As we have mentioned above, the macd histogram shows the difference between the two moving average lines. The histogram constantly fluctuates due to the movement of the lines. When the MACD line is above the signal line, the histogram will be positive. And when the MACD line is below the signal, the histogram will be of a negative value. When you get a zero value it is an indication of the buy or sell signals.
Now, let us look at the formulas used by the traders to calculate the moving average convergence divergence.
The formula is derived from the very components used in the macd trading indicator.
MACD line = 12 period EMA – 26 period EMA
Signal line = 9 period EMA
Histogram = difference between Macd line and the signal line
Therefore, Macd is calculated by subtracting 26-period EMA from 12-period EMA. when the shorter EMA converges towards and diverges away from, the longer EMA causes the Macd indicator to oscillate around the zero level and a signal line is created with a 9-period EMA of the MACD line.
What are the advantages of a Macd indicator?
Now that you have understood the working and use of the indicator let us list some of the advantages that you can benefit from:
- It helps traders identify trading signals, and price movements and analyzes the market.
- It is a useful trading tool that helps the trader to stay updated about the duration and direction of a market trend.
- The MACD indicator can also be used to verify whether or not a trend has a reversal which is again a major advantage over other technical analysis indicators.
- MACD is a short-term indicator, which makes it a useful tool for all short-term traders.
- The tool has been used in the market for over 40 years now and is still relevant and helps traders identify profitable opportunities.
What are the disadvantages of a macd indicator?
After, listing so many advantages, you might be wondering if the indicator has any limitations or drawbacks. The tool is a favorite amongst all traders but still watch out for the following limitations:
- While Macd indicator is advantageous for short-term traders, it can prove to be a limitation for long-term traders.
- Sometimes the MACD can prove to be is a slow indicator. Due to this, a trader can miss out on the early profits before entering the position at a later time.
- Macd trading is known to give traders false alarms. When the MACD predicts a shift in the momentum of an asset’s price, the price of the asset itself may not observe such a shift as well.
Macd trading strategies
There are a lot of Macd trading strategies that can be used by trades to find opportunities in the market. Take a look at some of the common trading strategies used:
Under this trading strategy, the MACD line and the signal line can be utilized as an oscillator, when the two lines crossover and provide buying and selling signals.
In the macd crossover strategies, the Macd line crosses above the signal line and provides a buy signal. Conversely, when the MACD line crosses below the signal line, it provides a bearish sell signal.
The strategy is based on waiting for a movement to occur before opening a position. if you look at a standard crossover strategy you will find that all the Profitable entry points are highlighted by green vertical lines, while the false signals are highlighted by red lines.
2. Zero crosses
In this strategy, the aim is to buy or close a short position when the macd line crosses above the zero line, and sell or close a long position when the macd line crosses below the zero line.
When using this strategy it is important to know when is the right time to exit the trade. For example: in case there is a bearish crossover, it can be a sign that the movement of the uptrend is slowing down and it can even change its direction.
Therefore, a trader with a long position should consider exiting the trade. If there is a sign of a downward trend the trader should exit the position.
3. The direction of the trade
One more helpful strategy is to identify the direction of the trade. You can do it by using the 200-day moving average tool. Identifying the direction of the trade can help traders determine whether the prices are consistently trading above the average range or below the average range. Based on this information they can make decisions to either buy or sell.
For example: when there is an upward trend, confirmed by prices consistently trading above the 200-day moving average, the trader can move on to determine possible entry points and buy.
4. Histogram Reversals
When the market price moves in favor, the histogram increases in height, and when the histogram falls, it means that the market is moving slower.
This means that as the bars on the histogram move further away from zero, the two moving average lines will move away from each other. this is a signal that the moving averages are tightening again, which can be an early sign that there may be a crossover.
This is knowns as the histogram reversal strategy. In this strategy, the known trends are used as the basis for placing positions, which means the strategy can be executed before the market movement takes place.
When is the best time to use The moving average convergence divergence (MACD) indicator?
If you know how to use the macd indicator well there is no such time as a ‘best’ time to use the MACD indicator. You can use it according to your know preference and trading method. Those who follow certain trading strategies or use a technical approach to analysis, or choose to use a variety of other indicators to determine price action may need to decide a time that would align with the rest of the factors.
If you choose a macd crossover strategy, you will have to watch your MACD indicator from time to time to receive the signals as quickly as possible. But if you chose a strategy, like a histogram, you can spend less time monitoring your MACD trading, as the signals present themselves ahead of time.
Is Macd trading reliable?
Though invented in the seventies, the MACD indicator is still considered to be one of the most reliable momentum traders’ indicators. the tool is accessible to both novice and experienced traders and allows for easier interpretation and confirmation. It is safe and reliable to use the macd indicator.
Well, if you want to take better trading decisions and make the trade process easy for you, you should use the macd indicator. In the above guide by forex broker reviews, we have helped you how to understand macd indicator, its uses, benefits, and even some macd trading strategies. We hope this guide proves useful to you.