The Moving Average Convergence/Divergence (MACD) is a versatile indicator. Moving Average Convergence/Divergence is one of the simplest and most reliable forex indicators. MACD will help you identify both the bull divergence as well the bear divergence which are rare but effective patterns.
This is a hybrid tool that is helpful in determining the present market direction as well as measure the price momentum. Many traders use MACD as their sole confirming indicator. This multi faceted indicator acts as a sign of the trend momentum by representing the relationship between the two moving averages.
MACD shows the divergence between two moving averages. The parameter of MACD are expressed as MACD “A, B,C” where A is the number of periods in the fast moving average, B is the number of periods in the slower moving average and C is the periods used to calculate the difference of the two moving averages.
The usual settings for MACD are 12, 26 and 9. MACD is calculated by subtracting the 26 day EMA from the 12 day EMA. A 9 day EMA of the MACD called the signal line is plotted on top of the MACD and acts as the trigger for the buy and sell signals.
The change of the two moving averages either closer to or further away from each other have predictive value. As the two moving averages approach each other in value, a potential crossover maybe forming. This means the current trend is losing momentum by slowing down and the market may be getting ready for a trend change. Similarly, as the trend strengthens, the two moving averages grow further apart indicating an increase in momentum.
The MACD chart has both a linear component as well as a histogram. The black line or the dark line is the MACD which is the difference of the two moving averages. This is the faster moving line. The light line is the signal line or the average of the MACD over 9 periods. It is the slower moving component. The two lines move closer to and further away from each other over time and occasionally will cross each other.
The Histograms shows the variations in the distance between the two fast moving and the slow moving lines. The histograms measure momentum. When the bars are moving away from zero, this is taken as positive momentum. When these bars move towards the zero line, this is interpreted as a decreasing momentum. Positive momentum means the current trend is strengthening whereas negative momentum means the current trend is weakening. These were the basics of MACD. In the next article, we will discuss how the buy and sell signals are generated with the MACD.