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MACD (Moving Average Convergence Divergence) in Forex Trading

Aug 18, 2007
Moving Average Convergence Divergence (MACD) is a tool for analyzing trends in the Forex market and is often used in many markets. It is considered one of the most reliable trend following momentum indicators currently available.

MACD illustrates the association between two moving averages of prices. The formula involves subtracting the 26 day EMA (exponential moving average) from the 12 day EMA. The "signal line" is plotted over the MACD. The signal line is the nine day EMA of the MACD and it functions as a trigger for buy and sell indicators.

When charting the MACD, the zero line is a base. It supports the indicator and provides an area of resistance. When there is a move above or below the zero line, it is indicative of the position of the short term average as it relates to the long term average. When the MACD rises above the zero line it suggests upward momentum.

This is because the short term average is above the long term average. When the MACD falls below the zero line, the opposite is true. When interpreting the MACD in Forex trading, there are three methods that are most common.

Crossovers

When watching the MACD, a drop below the signal line is a likely indicator to sell, meaning it is a bearish signal. On the other hand, when the MACD rises above the signal line, it is suggestive of the likely onset of upward momentum of the price of the Forex currency.

This would mean it is a bullish signal. Quite often, traders will wait before entering into a position for a confirmed cross above the signal line. Entering into a position too early can result in a false rise.

Divergence

A divergence signals the end of the current trend. It occurs when the price of the Forex currency deviates from the MACD.

Dramatic Rise

When the MACD experiences a dramatic rise, meaning that the shorter moving average is further distanced from the long term moving average, it is an indication that the Forex currency is overbought and will fall back to normal levels soon.

MACD can be found on most contemporary charting software. It is displayed as a simple chart, but only two different colored lines. One line is solid and the other is dotted, typically indicating the 12 and 26 period EMAs using the 9 period EMA as the signal line. It is one of the simplest form of trend indicators.

MACD is most beneficial because it offers characteristics of both trend and momentum in one indicator. It is most often dead on as a trend following indicator. There may be a brief lag because of the use of EMAs instead of SMAs (Simple Moving Averages).

MACD in Forex trading can be used to indicate momentum, foreshadowing moves in the underlying currency. However, while the moving averages are a benefit, they can also pose as a drawback to MACD.

This is due to the lag in the indicator. Prudent Forex traders, though, become skillful at reading the indicators, waiting out the lags and following the trends.
About the Author
Dave Hikade began trading over 10 years ago and offers a FREE Forex Trading Newsletter:

http://www.forex-trader-basics.info

For information on MACD and Technical Analysis in Forex Trading go here:

http://dachsales.com/rec/macd
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