MACD is a Moving Average Convergence Divergences indicator.
It was developed by Gerald Appel to detect swings in price of financial instruments. MACD is used by traders to identify reversal points in a trend and for trend confirmations. The moving average convergence divergence detect momentum change and signals over bought and over sold conditions.
It is composed of 2 parameters;
- MACD line
- Signal line
The MACD line which is the difference between the 26 period & 12 period of Exponential moving average and the signal line which is the 9 period exponential moving average of the MACD.
On Metatrader 4, the default MACD doesn’t have the main MACD line, it is represented by a Histogram(bars).
The histogram = MACD line – Signal line
When the MACD crosses the signal line, the histogram crosses the zero line and this gives a signal that a trend is likely to change.
If the MACD is above the zero line, prices are trending higher, and if below prices are falling
How a MACD looks like on an MT4 platform.
As the faster moving average moves away from the slower moving average, the MACD shows their relationship which is the divergence. While when the faster moving average gets closer to the slower moving average the histogram becomes smaller showing their relationship (convergence). That is the divergence and convergence but on the chart above it is combined in the histogram so is not visibly clear.
How to trade using MACD
One way to trade using a MACD is by looking at the MACD movements.
When the MACD histogram is above the zero line, it’s an indication of an uptrend, when it goes below it indicates a down trend. You can buy or sell at the shift of the MACD histogram above or below the zero line.
Looking at our chart below, when the MACD histogram crosses above or below the signal line gives a signal for a strong trend. And as it moves away from the signal line, it shows fall in momentum and may lead to a trend reversal.
Entry signals are when the MACD histogram and the signal line cross above/below Zero as shown on the chart below.
Trading MACD divergencies
The MACD is also used to identify possible reversal signals in form of the bullish convergences and bearish divergences.
For instance when market prices forms the lower low of the previous low and the MACD forms the higher low of the previous low, it is an indication that the low is fake( bullish convergences). This can result to a trend reversal(bullish reversal). Buy on the notice of this kind of behavior between price and the MACD.
Likewise when the market price makes a higher high of the previous high and the MACD makes a lower high of the previous high (bearish divergence) then the high is fake. Probable signal for a bearish reversal. Well, this says it’s time to sell.
The example below explains a bearish divergence between a MACD and price movement.
From our chart above, price and MACD make highs at A. Later on at B, price makes a higher high and MACD makes a lower high, that is a confirmed bearish divergence. Entry signal is when the histogram and the Signal move below the 0.00 line as shown on the chart above.
How long you should hold an open position, is a personal thing for all traders. The decision is all yours. You know what your goals are as a trader, the kind of strategy you use to trade. All this starts from what you are? and What you want? If I am to answer, this...