Moving Average Convergence Divergence (MACD) shows the difference of two moving averages - EMA12 and EMA26, and a 9-day EMA of the difference is plotted against it to trigger buy or sell signal.
There are three parameters in MACD:
1. Detect overbought/oversold levels
2. Crossovers
3. Divergences
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newdigital, 2013.07.31 19:53
MACD Strategy Center Line Crossover Bullish Signal and Bearish Signal
The MACD indicator is one of the most widely and
commonly used indicators available. MACD indicator is a momentum
oscillator with some trend following characteristics.
MACD is one of the most popular indicators used in technical analysis. It is used to generate signals using crossovers
MACD indicator plots the divergence and convergence of moving averages. It is constructed using moving average analysis. Moving Average Convergence/Divergence is a trend-following indicator. It indicates the correlation between two moving averages.
One moving average is of a shorter period and the other for a longer period of price bars
This indicator has a zero center line; values above zero line are bullish while those below zero are bearish.
In an uptrend the shorter MACD line rises faster that the longer MACD line this creates a gap.
In a downtrend the shorter MACD line falls faster than the longer MACD line this creates a gap.
When the trend is about to reverse the MACD lines start to move closer to each other, thus closing the gap.
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newdigital, 2013.08.01 09:16
MACD Oscillator Technical Analysis Fast Line and Signal Line
MACD is used in various ways to give technical analysis information.
MACD Construction
The MACD is constructed using two exponential moving averages and MACD indicator plots two lines. The two default exponential moving averages used are 12 and 26. Then a smoothing factor of 9 is also applied when drawing.
Summary of how MACD is plotted
MACD uses 2 EMAs + a smoothing factor (12, 26 Exponential Moving Averages and 9 smoothing periods)
MACD only plots two lines- the fast line and the signal line
Implementation
The MACD indicator implements the MACD line as a continuous line while the signal line is implemented as a histogram.
The fast line and signal line is used to generate trading signals using the crossover method.
There is also the center-line which is also known as the zero mark and it is a neutral point between buyers and sellers.
Values above the center-mark are considered bullish while those below are bearish.
The MACD being an oscillator indicator, oscillates above and below this center line.
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newdigital, 2013.08.01 13:12
MACD Technical Analysis Buy and Sell Signals
Since the MACD uses 26 and 12 EMA to plot, we shall compare these two EMAs with the MACD indicator to determine how these signals are generated.
The MACD is a leading indicator meaning it generates signals that are leading compared to price action as opposed to lagging indicators that lag behind the price.
MACD Buy
A buy signal is generated when there is a MACD fast line crosses above the signal line. However, as with any leading indicator these signals are prone to whipsaws/ fake out signals.
To eliminate the whipsaws it's good to wait for confirmation. The signal is confirmed when the two lines cross above the zero mark, when this happens the buy generated is a reliable trading signal.
In the example below, the Moving average generated a buy, before price started to move up. But it wasn't until the MACD moved above the zero line that the signal was confirmed, and the Moving Averages also gave a crossover signal. From experience its always good to buy after both the MACD lines move above zero.
MACD Sell
A sell signal is generated when there is a MACD fast line crosses below the signal line. However, just like the buy signal, these are also prone to whipsaws/ fake outs.
To eliminate the whipsaws its good to wait for confirmation of the signal. The signal is confirmed when the two lines cross below the zero mark, when this happens the sell generated is a reliable trading signal.
In the example below, the Moving average generated a sell confirmed after MACD moved below the zero line at the same time that the Moving Averages gave a crossover signal.
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newdigital, 2013.08.01 14:43
MACD Whipsaws and Fake Out Signals on Bearish and Bullish Territory
since the MACD is a leading indicator which sometimes give whipsaws, we shall look at an example of a whipsaw generated by MACD, so as to illustrate why it's always good to wait for a confirmation signal.
The MACD indicator gave a buy signal, when this signal was generated MACD was still below the zero mark. At this point the buy signal had not been confirmed and the signal resulted into a whipsaw as illustrated by the moving averages which continued to move downwards.
A whipsaw is as a result of dramatic rise and fall in the price in a short time and in such a manner that skews the data used in calculating the averages. These types of moves are usually brought about because of some news event that can produces market noise.
Traders should have the ability to gauge a whipsaw and
withstand the whipsaw; a whipsaw might result into an upswing session
and then a downswing session. To minimize the risk of trading whipsaws,
it's good to wait for confirmation of signals by waiting for MACD to
cross above or below the zero center-line mark.
Combining MACD Crossover with MACD Center-line to Prevent Whipsaws
Buy signal - When there is a MACD crossover, followed by a steep rise in price and then a center-line crossover the buy signal is confirmed.
Sell signal - When there is a MACD crossover, followed by a steep decline in price and then a center-line crossover the sell signal is confirmed.
Buy signal in Bearish Territory Whipsaw
When a buy signal is generated in a bearish territory, it might result into a whipsaw especially if it is not followed soon by a centerline crossover.
In the example below MACD gives a buy signal even though it is in bearish territory, the indicator then turns downwards and starts moving down again resulting into a whipsaw. By waiting for centerline crossover it is possible to avoid the whipsaw. However, in this case there was a brief centerline crossing; this whipsaw would have been hard to trade using MACD alone, that is why it is good to combine the use of MACD indicator with another technical indicator. In the example below the MACD indicator is combined with the moving average technical analysis.
Sell Signal in Bullish Territory Whipsaw
When a sell signal is generated in a bullish territory, it might result into a whipsaw especially if it is not followed soon by a center-line crossover.
In the example below MACD gives a sell signal even though it is in bullish territory, the indicator then turns up and starts moving upwards again resulting into a whipsaw. By waiting for center-line crossover it is possible to avoid the whipsaw. In the example below by combining MACD with the Moving Average Crossover Trading System you would have avoided this whipsaw.
To avoid whipsaws completely when trading with the MACD Indicator it is best to use the Center-line Crossover signal as the Official Buy or Sell Signal of The MACD Indicator.
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newdigital, 2013.08.01 16:52
MACD Indicator Fast Line and Center Line Crossover
MACD Center line crossovers generate Forex trading signals using the MACD center line. The sentiment of the Forex market can be confirmed using MACD crossovers. MACD crossover above the center mark generates bullish Forex market sentiment while crossover below the center line generates bearish market sentiment.
Using the EURUSD Forex chart in the example below, when MACD fast line crossed below the zero line, the sell signal was confirmed and the market sentiment changed to bearish.
Also in the example below when MACD fast line later crosses above zero line a buy signal was generated and the market sentiment changed to bullish.
Oscillation of the MACD indicator
The MACD Forex indicator is an oscillation indicator that moves up and down around a zero mark. The center-line is the neutral measurement, values above zero will indicate bullish Forex market conditions while values below indicate bearish forex market region.
The MACD is also used to indicate overbought and oversold levels. When the MACD reaches overextended levels, then a currency is overbought or oversold. However, in a strong upward trending market prices will stay overbought in this case its better to buy.
Also in a strong down trending Forex market its better to sell, because prices will stay in the oversold region for a long time.Overbought conditions occur above the zero line while oversold conditions occur way below the zero mark.
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newdigital, 2013.08.01 16:56
MACD Classic Bullish and Bearish Divergence
MACD Classic divergence is used as a possible sign for a trend reversal. Classic divergence is used when looking for an area where price could reverse and start going in the opposite direction. For this reason classic divergence is used as a low risk entry method and also as an accurate way of exit out of a trade.
1. It is a low risk method to sell near the market top or buy near the market bottom, this makes the risk on your trades are very small relative to the potential reward.
2. It is used to predict the optimum point at which to exit a Forex trade
There are two types:
Classic Bullish Divergence
Classic bullish divergence occurs when price is making lower lows (LL), but the oscillator is making higher lows (HL).
MACD Classic bullish divergence
Classic bullish divergence warns of a possible change in the trend from down to up. This is because even though the price went lower the volume of sellers that pushed the price lower was less as illustrated by the MACD indicator. This indicates underlying weakness of the downward trend.
Classic bearish divergence
Classic bearish divergence occurs when price is making a higher high (HH), but the oscillator is lower high (LH).
MACD Classic bearish divergence
Classic bearish divergence warns of a possible change in the trend from up to down. This is because even though the price went higher the volume of buyers that pushed the price higher was less as illustrated by the MACD indicator. This indicates underlying weakness of the upward trend.
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newdigital, 2013.08.01 17:00
MACD Hidden Bullish and Bearish Divergence
MACD Hidden divergence is used as a possible sign for a trend continuation.
This setup occurs when price retraces to retest a previous high or low.
1. Hidden Bullish Divergence
2. Hidden Bearish Divergence
Hidden Bullish Divergence
Forms when price is making a higher low (HL), but the MACD oscillator is showing a lower low (LL).
Hidden bullish divergence occurs when there is a retracement in an uptrend.
MACD bullish divergence
This divergence confirms that a retracement move is complete. This divergence indicates underlying strength of an uptrend.
Hidden Bearish Divergence
Forms when price is making a lower high (LH), but the MACD oscillator is showing a higher high (HH).
Hidden bearish divergence occurs when there is a retracement in an uptrend.
MACD bearish divergence
This setup confirms that a retracement move is complete. This diverging indicates underlying strength of a downtrend.
NB: Hidden divergence is the best divergence to trade because it gives a signal that is in the same direction with the trend. It provides for the best possible entry and is more accurate than the classic type of diverging.
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