MACD (pronounced “ MAC – dee“ or “M-A-C-D“) stands for Moving Average Convergence Divergence.

In forex trading, this popular and versatile tool is used for technical analysis. Majorly, it is used either as a trend or momentum indicator.

MACD was developed in 1979 by Gerald Appeal, who was an experienced trader and market technical analyst.

And, over the past few years, the use of MACD has become widespread among forex traders.

MACD calculates the difference between the 12 and the 26 exponential moving averages (EMAs). The 12-period exponential moving average is the faster one while the 26-period exponential moving average is the slower one.

The difference between the two moving averages is what is shown in a single line that is the MACD main line. Often, MACD indicators comprise of one extra line, which is a simple moving average of the main line. This moving average usually has the default setting of 9 in most trading platforms.

In MT4 trading platform, the default MACD lacks the main MACD line, but instead it has bars (histograms).

However, on other trading software, both the MACD main line and the MACD histogram are easily identifiable.

 Advantages of trading using MACD

One of the key reasons why most forex traders experience huge losses is because of being impatient.

Majority of traders are not patient enough to wait for a trade setup to develop to maturity. After glaring at their computer screens for an extended amount of time, they lose their patience and try to compel the market to obey them, instead of them obeying the market. As a result, they lose a lot of cash.

On the other hand, there is a group of traders who exit quickly winning trades with a small amount of profit.

They do so in the fear that the market may turn against them and erode the already won profits.  This means that they are not patient enough to remain in the trade till it hits the target. As a result, they limit the amount of returns per trade.

The good news is that MACD provides a good solution to this common problem. Since MACD is a lagging indicator, its delay compels you to wait more for sharp and clear signal.

As such, when you are waiting for a ripe opportunity to enter a trade or you’re already in a trade, you will not make hasty decisions.

From experience, we have learnt that there are some instances that other indicators and even the price chart indicate a trade opportunity but MACD gives the reverse – it indicates that waiting is still necessary to avoid going against the trend and causing unnecessary damage to the trading account.

There are also some other instances in which we think it is the right time to follow a trend but MACD makes us to re-think because it signifies that we are too late and the trend is worn out and may soon change its direction.

In this article, we will give you all the details on how to make MACD become a useful tool for your trading.

Uses of MACD in forex trading

• Analyze momentum and measure the strength of the trend
• Identify divergences between MACD and price to signal potential market turning points
• MACD cross-over used for giving entry and exit signals

i)                    Analyze momentum and measure the strength of the trend

When MACD is plotted on a price chart, its use becomes clearer. As earlier mentioned, the histograms give the difference between the 12 and the 26 exponential moving averages.

On the chart below, 12 (aqua) and 26 (red) exponential moving averages are drawn.  On the chart, it is evident that any time the distance of these two moving averages become longer, the histograms are also longer.

And, any time these two moving averages cross each other, the length of the associated histograms is zero.

As it is evident on the chart, when there is bullish momentum, MACD bars go above the zero level. And, when there is bearish momentum, MACD bars go below the zero level.

MACD is also very helpful in measuring the strength of the trend. The zero level of the MACD determines the trend of the market.

If MACD is above the zero level, then it indicates an uptrend. On the other hand, if MACD is below the zero level, then it indicates a downtrend.

Importantly, MACD can help you avoid placing trades against the trend. Since MACD is said to be a lagging indicator, when you spot a reversal signal in the market and you want to take a position against the trend, the indicator advises you otherwise.

Therefore, you can use MACD in forex trading to your advantage.

ii)                   Identify divergences

Divergences are one of the prominent and reliable trading signals that MACD generates. Divergences are seen by comparing price action and the movement of the MACD indicator.

In the forex market, price and momentum usually move hand in hand. Therefore, if price is making higher highs, then the indicator giving momentum ought also to be making higher highs.

On the other hand, if price is making lower lows, then the indicator ought also to be making lower lows.

And, if this is not the case, then it implies that the price and the indicator are diverging from one another. This is what is referred to as ‘divergence.’

MACD divergence is seen when either price makes higher highs and MACD bars make lower highs (bearish divergence) or when price is making lower lows and the bars are making higher lows (bullish divergence).

Here is the rule: price will ultimately follow the MACD direction and will reverse to the downside or the upside, based on whether the divergence is bearish or bullish.

Nonetheless, we have realized that it’s not easy to know when the reversal to the MACD direction will take place.

Therefore, if you are impatient and enter a sell order immediately you spot a bearish MACD divergence, then you can be in for a big shock, as price may continue rising by numerous more candlesticks.

As such, it is advisable you enter a sell order when MACD divergence is followed by a good confirmation such as a clear break of a major support level.

MACD divergence normally appears towards the end of up trends or downtrends. Thus, it signifies a weakening trend or an imminent trend reversal.

iii)                MACD cross-over

To illustrate this better, we will use another version of MACD (It does not come with the metatrader platform).

Since there are two moving averages with different speeds, the quicker one (fast moving average) will clearly respond to price action than the less quick one (slow moving average).

If a new trend takes place, the quick line will respond first and ultimately cross the slower line. And, if this “cross-over” takes place, the quick line starts to diverge or move away from the less quick one.

This is what depicts that a new trend has emerged.

From the chart above, it is evident that the fast moving average closed below the slow moving average to rightly identify a new downtrend.

And, when the lines crossed one another, the histogram temporarily disappears because the difference between the lines at that moment is zero.

As the downtrend starts and the fast moving average moves away from the slow moving average, the histogram starts getting bigger. Thereby, this indicates a strong trend.

Here is MACD cross-over:

Therefore, you can use MACD cross-over points to identify places of entry and exit in the market.

For example, in the example above, you could reap big pips if you placed a long order immediately after the cross-over.

Summary

Just like with the majority of technical indicators available out there, it is important that you use MACD as a secondary indicator when trading currencies.

You should not use MACD the same way you use primary technical indicators such as trend lines, chart patterns etc.

It is essential that you use MACD in forex trading only for confirming the signals that your primary indicators are giving.