MACD (Moving Average Convergence Divergence) is a technical momentum indicator tool used by traders to measure the price relationship between two moving averages. The momentum indicator tool follows the market trends with a display of three lines. The three lines are blue, representing the MACD, red, the signal line, and green for the histogram or the difference between the blue and the red line.
How MACD works
The signal line and the MACD line are the ones taken into consideration when calculating the MACD. There are mainly two moving average periods-the longer-term and shorter-term moving averages. The longer-term period has a total of 26 days, while the shorter term has 12 days.
The MACD line is a subtraction of the longer period moving average-26 from the shorter-term moving average-12. A 9-period moving average represents the MACD signal line. It is also a graphical portrayal of the distance between the signals, with the MACD line shown as a histogram.
If the MACD slices through the signal line from beneath, forex traders can read that as a signal to buy. If it slices above the signal line, it is a sign that they can sell. When moving averages inch towards each other, a convergence occurs. When they move far apart from each other, there is a divergence.
Functions of MACD
The MACD has the same attributes as an oscillator as it provides traders with overbought and oversold signals. The lines falter in and around zero, which means the signals can be above or below the zero line. The main functions of MACD are as follows;
An indicator for trend direction-it gauges the current trend strength signaling whether it should be a buy or a sell. If there is an uptrend, the signal is above zero or in the positive zone. If there is a downtrend, the signal goes below zero or the negative zone.
Indicator for entry-it helps identify entry or open positions on the buy and sell counter, which implies that you can use the counter to buy or sell based on the signal you get.
Measures momentum-one of the main functions of MACD is to measure momentum, which forms in the histogram. Momentum is strong when the histogram stems’ formation gets thicker, while it is weak when the formation is thinner or smaller.
Oscillator-it determines overbought and oversells moments allowing you to get ready to sell if you are entering the overbought condition and to sell when the condition calls for oversold.
Pros and cons of using the MACD
- Reliable and simple
One of the reasons many traders use MACD is that it is simple and reliable to use, even for novices. The popularity of the technical trading tool stems from the two signals it provides traders with. The signals help the forex traders to identify the trend strengths and turning points. Besides determining when the trend is up or down, MACD also helps provide buy or sell signals.
- Up-to-date representation
Using the Simple Moving Average strategy is popular with many forex traders. However, in some instances, it delays the sell and buy signals that change the market conditions before executing a trade. MACD, on the other hand, provides traders with a representation of the current things happening on the money market, making it a popular technical trading analysis tool.
- Not suitable for long-term trading
MACD has a 26-day moving average measurement, making it hard for traders with longer-term trading outlooks to use it as their analysis tool. However, it is a great choice for short-term traders.
- Does not recognize upcoming trends
If you want to know about upcoming or future trends, MACD will not help because it only provides signals for trends as they occur and not before they do.
Wrapping it up
MACD is one of the most preferred technical indicator tools because it provides traders with different signals that provide them with the perfect trading foundation. However, using the indicator tool all by itself may provide you with false signals, which is why it is wise to use it alongside other technical analysis tools such as moving averages.