MACD is one of the essential technical indicators that helps a myriad of traders win from forex trading. All it takes to use the trading tool is to learn how to read it.
A MACD reading that is above the signal line reflects in a histogram above MACD’s baseline. A reading below the MACD line symbolizes a histogram under the MACD baseline. MACD’s histogram guides you in identifying a high bullish or bearish momentum.
Here is what you should know about MACD to understand the seemingly complex technical terms.
What Is the Implication of Momentum Indicators?
The broad classification of technical indicators has four branches. These are trend, momentum, volatility, and volume.
The trend shows the direction of prices according to past data. MACD, Bollinger bands, RSI, and Average Directional Index (ADX) are examples of trend indicators.
Volatility indicators show the price quantity that projects in a direction. Examples of volatility indicators are Bollinger Bands.
On the other hand, volume indicators help in determining the number of currency pair sold and bought. The most typical volume indicators are On-balance volume (OBV), Chaikin money flow, and Klinger oscillator.
Lastly, a momentum indicator helps you determine the rate at which a currency pair price changes. Examples of momentum indicators are RSI, ADX, and MACD.
What Is MACD?
Moving Average Convergence Divergence is one of the most critical technical indicators that converts two moving averages into a momentum indicator by subtracting the longer moving average (MA) from the shorter MA.
As the two moving averages converge, diverge, or cross, the MACD fluctuates above or below zero.
Gerald Appel developed the MACD indicator in the late seventies. Besides momentum, the technical indicator shows a currency pair price’s strength, direction, and duration.
The default computational days are 26, 12, and 9. However, you can change the values depending on your trading style and goals. The values help calculate the MACD, as shown below.
The first step to calculating the MACD is to collect past closing forex currency prices for the period whose MACD you want to calculate. Next, determine the exponential moving average for the shorter and longer days.
In this example, we shall use 12 and 26 EMA. Before proceeding, here is what you should know about moving averages.
Moving averages (regarding forex trading) are technical indicators that collect a currency pair’s past data for a particular trading period then divide it by the number of days in the period.
The average is referred to as ‘moving’ since the computations keep changing as the currency pairs’ price and traded volume change.
Moving averages subdivide into simple moving average (SMA) and exponential moving average (EMA). The difference between SMA and EMA is that EMA gives a better picture of the current price, while SMA better reveals its strength from a historical point of view.
Since the MACD shows both trend and momentum on a single indicator, EMA is more applicable to express a better pictorial representation of the overall price average.
Let’s now find the MACD line, signal, and histogram. The formulae are:
MACD Line = (12-day EMA - 26-day EMA)
Signal Line = 9-day EMA of MACD Line
MACD Histogram = MACD Line – Signal Line
Here are the implications of the above calculations:
Reading the MACD
- The plotting of the exponential moving averages (EMA) of the MACD line accompanies that of the indicator to symbolize the signal line and represent the turning points.
- While the MACD line shows the difference between the 12-day and 26-day EMAs, the histogram echoes the difference between 9-day EMA and the MACD line.
- A positive histogram occurs when the MACD line rises above the signal line, whereas a negative one happens when the MACD line falls below its signal line.
- Positive MACD results when the 12-day EMA diverges from the 26-day EMA, signifying an increasing momentum. The falling of the 12-day EMA below the 26-day EMA shows negative MACD—a decreasing momentum.
Conclusion The moving average convergence divergence is a crucial technical indicator that helps you determine the trend and momentum of a currency pair. Reading it requires focusing on its baseline, signal, and the resulting histogram.