To be a successful forex trader, you must learn how to use the technical indicators, at least few most important ones. These technical indicators are very useful parameters that forecast, with a high probability, the future trend of the market. Moving Average Convergence Divergence or MACD is one such detailed method of using moving averages to find trading signals from price charts.
MACD was developed by Gerald Appel in 1979. It plots the difference between a 26-day exponential moving average (EMA) and a 12-day exponential moving average. A 12-day EMA is obviously faster than the 26-day EMA. A 9-day moving average is generally used as a trigger line, to indicate a bearish signal (time to sell) or a bullish signal (time to buy).
Moving Averages is your “trendy friend”. It tells you the average price in a given point of time over a defined period of time. They are called moving as they reflect the latest average, while adhering to the same time measure. The MACD histograms are remarkable visual representation of the difference between MACD and its 9-day EMA. If prices are rising, the histograms grow larger as the speed of the price movement accelerates and contracts as price movement decelerates.
There are three kind of moving averages: Simple MA, Linearly Weighted MA, and Exponentially Smoothed. The latter is preferred as it assigns greater weight for the most recent data. It also considers data in the entire life of the instrument making it a more accurate indicator.
Forex traders study MACD to look for early signals or divergences between market prices. If the MACD turns positive and makes higher lows while the prices are still tanking, this relates to a strong buy signal.
On the other hand, if the MACD makes lower highs while prices are making new highs, this indicates a strong bearish divergence and a sell signal. Although trading divergence is a popular way to use MACD histogram, it is not very accurate. So it is better to use the histograms for trade-entry and trade-exit.
MACD in forex trading responds to the speed of price movement. Most of the forex traders use this to measure momentum and to gauge the strength of the price move than to determine the direction of a trend.
We must remember, MACD is just a technical indicator. A serous weakness of MACD is they lag the market. To overcome this problem, it may be used in combination with two averages of distinct time frames.
However, a logical and methodical approach in managing the rules will result in higher gains. The concept of MACD histogram offers a new way to trade an old idea in forex. It ensures huge scaling up of positions and applies equally for day trading and position trading.
By: Paul Bryan
About the Author:
To learn how to trade Forex profitably visit Forex Trading MACD
