The MACD is one of the most popular and broadly used indicators for Forex trading. The letters M.A.C.D. is abbreviation for Moving Average Convergence Divergence. The MACD indicator, which requires Moving Averages as its input, falls into the group of the lagging indicators.
The basic function of the MACD Forex indicator is to discover new trends and to help identify the end of current trends. There are various ways to gauge the signals generated by MACD, and many traders use their own unique settings and methods around this trading indicator.
Understanding the MACD Indicator
The MACD indicator is typically placed at the bottom of the trading chart, in a separate window, beneath the price chart. The Moving Average Convergence Divergence is a relatively easy-to-use tool, however, it is crucial to understand it fully before attempting to trade using its signals. Let’s take a close look at the structure of the MACD indicator and its default settings.
The MACD indicator consists of three components. There are two lines and a histogram. Let’s now discuss each of these separately:
- MACD Line – The MACD line is the faster line on the indicator. Since it reacts faster it and is more sensitive, it generally moves above and below the second line of the indicator.
- MACD Signal Line – The MACD signal line is the second line of the MACD indicator. It is called a signal line, because it generates the basic MACD signals. Since the line is slower, it gets frequently breached by the faster MACD line.
- MACD Histogram – The MACD histogram simply represents the difference between the MACD line and the signal line. The bigger the gap between the lines, the higher the bars that the MACD histogram will display.
Below you will see an example of the MACD indicator:
This is a zoomed image of the MACD indicator. The blue line is the MACD line. The red line is the signal line. As you see, the MACD line is faster and it often breaks the signal line. The gray bars are the histogram, which move in harmony with the distance between the two lines of the indicator.
On most trading platforms, the MACD indicator typically comes with the default parameters 26, 12, and 9. We will interpret the meaning of these three numbers and how they apply to the structure of the indicator.
The “12” and “26” are mutually related. These two numbers concern the calculation of the faster MACD line. The structure of the MACD line comes with calculating a 12-period Exponential Moving Average on the price action and then subtracting a 26-period Exponential Moving Average from the result. The difference between the two EMAs gives you the value of the faster line.
The “9” comes from the calculation of the slower line a.k.a. the signal line. This line is a product of a 9-period Exponential Moving Average plotted on the faster MACD line. This is why the signal line is slower than the MACD line – because it is the smoother version of the MACD line.
Although the MACD indicator consists only of three components (the two lines and the histogram) it can provide a myriad of signals. We recognize six basic signals of the MACD and now we will discuss each of these separately.
The MACD crossovers involve the interaction between the two MACD lines. The MACD line is faster than the signal line, and it will typically cross above and below the slower signal line.
- Bullish MACD Crossover – We have a bullish MACD crossover when the MACD line crosses the slower signal line in the bullish direction. This action generates a bullish signal on the chart, which implies that the price might start an increase.
- Bearish MACD Crossover – The bearish MACD crossover is opposite to the bullish MACD crossover. When the MACD line crosses the signal line in the bearish direction, we have a bearish crossover. This hints that the price action might be entering a bearish move.TO BE CONTINUE…