Moving Average Convergence Divergence (MACD)

Moving Average Convergence Divergence (MACD)

The MACD indicator is an extension of the moving average indicators that we talked about previously. The MACD indicator uses two different EMA indicators as the input into its formula. Unlike moving averages only, the MACD is an indicator of when to buy and sell a particular currency pair.

The MACD is calculated by subtracting the 12 day EMA from the 26 day EMA. Further, a 9 day EMA line is used and is termed the “signal line”. These two lines are plotted together and the 9 day moving average is used as the indicator of whether to buy or sell. In the graph on the right, we have the price of the Japanese Yen and the corresponding MACD chart and signal line.

Moving Average Convergence Divergence (MACD

As a general rule of thumb, when the MACD indicator is below the signal line then this could be an indicator to sell the pair and the opposite can be said when the indicator is above the signal line.

Conversely, when the signal line diverges from the MACD then the trend that was in place can be considered over and traders should take caution. Traders should also be aware of strong upward moves in the MACD as this could be an indicator that the currency pair has been overbought and the 12 day moving average is increasing substantially compared to the 26 day one.

Algorithmic trading software also uses the same logic when producing trading signals for traders who subscribe to the signals. The software will monitor the levels of the MACD and the signal line and generally adjust the signals being generated based on historical volatility. If the uptick in the MACD is within previous standard deviations then overbought signals will not necessarily be issued.

When making use of MACD trading signals, keep these in mind before entering your trades.

  • As always, have a set maximum that you are willing to invest as a percentage of your total capital balance.
  • Entry decisions should be based on how far the signal line is from the MACD indicator. This should also take into account how volatile the indicators have been in the past in relation to the current observed movement.
  • Entry and Exit levels should be based on the observed prices over the past 4 candles.
  • If trading Forex on margin, you should have adequate stop losses in place that are well placed to obtain the desired return on the upside but also won’t allow for too much drawdown if a reversal were to occur.
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