Trading Forex with the Moving Average Convergence Divergence Indicator

The MACD is a popular trading indicator developed by Gerald Appel and stands for Moving Average Convergence Divergence. The standard settings for the MACD are moving average periods of 12, 26, and 9. Moving averages are momentum indicators that generally lag the market. The MACD does however offer a trending element.

Most popular charting packages will include either a MACD line, or grid indicator or both. On the attached chart I have included both.

The 12 represents the fast moving average (MA) of the previous 12 bars. The 26 slow MA represents the average movement of the previous 26 bars. The 9 represents the average movement of the previous 9 bars of the difference between the fast and slow MA and is generally represented as the grid lines on the indicator. This line oscillates above and below a zero line without any upper or lower limits.

When price crosses above the Zero line it generally confirms the new bullish trend. When it crosses below the zero line it confirms the new bearish trend.

When the histogram bars get longer and start to move away from the MA we call this divergence (diverges away) and when they get shorter we call this convergence (converges towards) the MA.

The MACD is traded in a number of different ways. The most popular method seems to be a cross of the zero line. When price crosses above the Zero line it confirms the bull trend and traders enter the market long.. As it is a lagging indicator made up of moving averages of moving averages further smoothed by another moving average the Zero line cross could occur well after the start of the reversal. The cross of the zero line does however confirm the new trend is in tact and can often be a safer entry.

When price crosses below the zero line it confirms the bearish trend and traders enter the market short.

Depending on the market volatility the zero line cross may only occur towards the end of a rally leaving most of the money on the table, or near the start of a rally capturing most of the profit. Therefore it is best used in conjunction with another indicator to filter out any false signals that might occur.

Alternately more aggressive traders will enter the trades when the 2 MACD lines cross rather than wait for a cross of the zero line allowing for a much earlier entry but probably prone to more fake outs and false signals.

(Click on chart to enlarge)

As we can see from the above chart, the line MACD cross creates a number of false signals on the 1st bull trend. It also proves far more rewarding on other trades with the earlier entry signals.

The MACD is also a useful indicator for identifying divergence that occurs when the market is going in one direction and the indicator in the opposite direction. Divergence alerts traders to a possible reversal in trend enabling an early entry in the market.

The chart shows good examples of all three methods of trading the MACD. As with all indicators it is wise to use another indicator in conjunction with the MACD to confirm entries and filter out potential false signals.

To summarize: the MACD is a lagging momentum indicator with a trending element that is useful for entering a trade and confirming a trend.