In this article we discuss the use of the MACD Indicator in FX trading, for some practical examples of how the indicator works as well as a little more description on how the indicator works, please watch the video at the bottom of this article.
The MACD indicator is a momentum indicator that stands for Moving Average Convergence Divergence. Although this sounds like a complicated name, the indicator is reasonably easy to use. The MACD indicator works as follows. A longer period (usually 26 period) exponential moving average (EMA) is calculated. This is the compared to a shorter term EMA (usually 13 periods). By construction the difference between these two moving averages must converge and diverge as the shorter period moving average will react faster to momentum changes compared to the longer term moving average.
What traders look for is when the two lines cross over. If the shorter term moving average crosses the longer term one from below (in the chart below this is the blue line crossing the red), this is the sign of a possible new uptrend and is thought to be a strong buy signal. If, however, the shorter term EMA crosses the longer term one from above (seen in the chart below and labelled sell), this is thought to be a sign that a particular cross currency is losing momentum and that a new down trend will prevail.
A couple of tips about using this indicator - it’s best used with longer time periods as there are a lot of false signals when looking at 1, 5 and 15 minute data. False signals are the two lines continually crossing over during short time periods which can lead to erroneous trading. The best results are also shown when the lines converge below the zero mark in the MACD when buying or above 1 when the lines cross when selling short.
The indicator can be used by itself, however, it is often used in conjunction with a particular technical analysis chart patter, such as a head and shoulders top or bottom or a double top or double bottom. The MACD indicator often confirms these chart patterns and when they both line up, it often leads to a very profitable trade.
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