One popular technical trading indicator is the Moving Average Convergence Divergence, or MACD. The MACD indicates whether moving averages may be signaling the start of a new trend. MACD can be used to spot either a bullish or bearish trend forming. Most traders succeed more easily with trend movements than during times of consolidation, so the MACD can point the way to many good trading opportunities. This is a common trading method, so most Forex trading brokers include MACD in their indicators.
When you chart the MACD, you will see two moving averages, one faster and one slower, and a corresponding histogram. This is a lagging indicator, since it is based off of moving averages, which are calculated according to the past. There are three numbers which you have to set to graph the MACD. The first number is the periods to calculate the faster of two moving averages (not the ones on the chart!); the second number is for the periods to calculate a second, slower one. The third is the number of bars which is used to calculate the moving average of the difference between the original two moving averages.
Now here’s the confusing part. The two moving averages you see on the MACD chart are not the moving averages of the price. They are moving averages of the difference between two moving averages. The first moving average you see plotted is the moving average of the difference between the faster and slower averages you set in the options. The second, slower moving average which is plotted is the average of that line calculated by the period of the third number you chose.
The histogram is the simple part of the MACD. The histogram is just a plot of the difference between the two MACD averages. As the two averages separate, the histogram reflects that by expanding. When they come together, the histogram contracts. When the expansion occurs, we call it “divergence.” When the histogram contracts, we call it “convergence.” This is of course where we get the name Moving Average Convergence Divergence.
What you’re looking for is for the faster moving average to cross above or below the slower moving average, and for divergence to form in the histogram. This tends to indicate that a new trend is forming. This is an entry signal.
So as you can see, the way in which the MACD is calculated is a bit complicated, but once you play around with some numbers and try it yourself, you will probably be able to understand how it is created. Fortunately for you, all you have to do to make the MACD lines and histogram is choose the periods of the moving averages which go into the calculations. Again, Forex trading brokers almost always include the MACD as a tool on their charting platform. Trading the MACD is pretty easy. Just look for the crossover and the divergence, and be ready to enter the trade! Make sure you have an exit strategy before entering any trade, and do some testing before you decide to trade the MACD with real money.
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