How to Use the MACD Indicator
Trading is all about finding the right trend because that is where you will be able to make all the money. One of the most effective ways to discover the moving averages because they direct you towards any new trend. MACD indicator stands for Moving Average Convergence Divergence which is a great indicator of the direction, strength, and momentum of the changes in the prices which are likely to take place in the market. This helps the trader in deciding an ideal exit point from the market.
In an MACD chart, you will find three numbers which are utilized in the settings:
- The first one tells about the number of periods which is used to calculate the faster moving average.
- The second one indicates the number of periods which showcase slower moving averages.
- The third is the number of bars which is used to determine the difference between the faster and slower moving averages.
The values are plotted with the help of a histogram which indicates the numbers in the form of bars. If the MACD indicator shows “12, 26, 9” then there are 12 bars of faster-moving average, 26 of slower ones, and 9 is the difference between the two.
There is a very common misconception about the MACD lines. They do not indicate the moving averages of the price instead, are actually the difference of the moving averages of the price. The faster moving average line will be the difference between the higher and the lower values whereas the slower moving line is the difference between the slower and some previous value. The result of these two moving averages line will be the third which is the 9-period moving average.
The histogram simply plots the difference between the two moving averages. We see as the difference starts increasing, the bars of the histogram get bigger. This is called the divergence in the MACD indicator. As the two moving lines are farther away, their difference is more which is then shown through the larger histogram bars.
When the faster moving averages line and the slower moving averages line get closer, the bars of the histogram shrink. This is the convergence of the two moving averages line. This is how the name MACD which is Moving Average Convergence Divergence comes into existence.
Using MACD in Trade
The two lines have different speeds with the faster one reacting to any change more quickly than the slower one. Whenever a new trend takes place, the faster line reacts immediately and eventually crosses the slower one. After this crossover, the line starts to diverge from the slower one.
When the two line cross the histogram reaches the value of zero as there is no difference between the two lines. As the downtrend of the faster line begins, the histogram gets bigger indicating the existence of a very strong trend.
MACD represents moving averages of other moving averages which itself is quite a lag. Even the lines are smoothed out by other moving averages but still it does give out a clear idea of the market and is considered as one of the most preferred tools by the traders.