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MACD and its Importance as a Forex Indicator

What is the MACD?

Moving Average Convergence/Divergence (MACD) is usually displayed as two lines of different colors that criss-cross atop the forex chart. One line is the MACD line itself and the other is called the signal line.
MACD also plots as a histogram. In this case it is a sort of bar chart in the window just below the currency pair prices chart. In the MACD histogram one line signals the zero point. This is called the center line. Then the bars of its chart rise and fall above and below that center line like a wave. The histogram brings forth the difference between the MACD line and its signal line. When they cross each other, the histogram will read zero.
MACD can indicate when currency pair is overbought or oversold. When does that happen? When the lines of the histogram get terribly long, there is a possibility of a reversal occurring and so you could figure out if there is an overbought or oversold condition.
MACD could also indicate divergence. For example, if the price of a currency reaches a new high or low and simultaneously if the MACD line doesn’t match that event then it only means that a trend reversal was around the corner. Again the fact that price and MACD don’t match indicates a momentum that were only weakening.

When would you use the MACD?

By now you would be wondering what all this technical mumbo jumbo is about. More importantly you would be thinking when exactly you would or could use the MACD.
MACD is best used when the market breaks out of a range bound activity. In other words MACD could be used along with the momentum technique when the market were rising above resistance or dropping below support. What happens then is that you could be entering into a position trade which could last for several days although you may have to pay a small overnight renewal fee to keep the trade active. Remember that these trades generally tend to bring in the maximum profits.

Technicalities of MACD

macd
In the diagram above, the MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the “signal line”, is then plotted on top of the MACD. This line functions as a trigger for buy and sell signals. Sometimes the software platform with which you trade the forex would want you to set the configuration of the MACD. In that case, the optimum setting for the indicator lines is 12 and 26-day EMA and for the signals line it is 9-day EMA. Ideally you should select settings that suit your trading style
If the MACD line crosses the signal line it means that it’s good time for entry in the direction the MACD line were going. But remember to look for a short trade if MACD line falls below signal line and if it rises above signal line just go along. Now assuming that the price of the currency pair breaks above resistance or below support after the MACD crosses the signal line, then it would be considered as a signal of a big move indeed happening. Both the upward and downward crosses are explained in the diagram above.
Why wouldn’t MACD work in a range bound market? The problem is that in a range bound market, if you base your market entry points only on the MACD then by the time the indicator catches up to the current price, the price may have risen or fallen terribly to such an extent that making a profitable trade would be near impossible.
Then there is always the possibility of MACD signals showing divergence also. For example assume for a moment EUR/USD breaking resistance and reaching new highs. The MACD would have signaled the break by crossing the signal line but since price continues to rise, the MACD line doesn’t reach new highs possibility indicating divergence. You would start thinking the trends were weakening but in the meantime you would have noticed that the price has continued to rise.

Conclusion

As with most technical indicators MACD determines the trend. If you stay with the trend you could become a successful forex trader. Finally in a practical sense MACD denotes the simple convergence of two moving averages. For example, it could appear as the average price line for the past week crossing over (perhaps up or down) the average price line for the past two weeks. A rising MACD indicates a rising price. When the two lines meet it is considered a neutral situation. Finally a decline below neutral usually indicates a short term declining trend. As a beginner it would suffice to know just the basics of MACD as elucidated above. But if you want to know more of the MACD and how it is constructed you would do well to join forums or search the Internet.

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