One of the main factors of success in forex trading is a good grasp of technical analysis techniques and tools. One of the most popular tools for technical analysis is the moving average convergence/divergence or MACD.
Every professional or advanced trader knows about MACD and uses it regularly in their trading activities. As an aspiring or beginner forex trader, it is also crucial that one knows about this highly praised technique.
Definition of Moving Average Convergence/Divergence
The MACD is a technical analysis tool that enables traders to monitor the momentum of price movement. Also, the MACD is used to identify market trends as it also helps traders identify support and resistance levels of a particular currency pair.
The MACD was developed in 1979 by Gerald Apel a stock trader. When it proved to be a useful indicator, it became common to use across the financial markets.
It consists of three items. First, is the MACD line which monitors the difference between two moving averages. Secondly, the signal line. This line is the momentum indicator and offers traders buy and sell signals. The third component of the MACD is a histogram graph that shows the difference between the MACD and the signal line.
On the histogram, the lower the difference between the MACD and the signal line, there is convergence. This can be seen as the lines come closer together. Divergence means that the difference between the MACD and the signal line is high and on the chart, the lines are moving away from each other.
Using The MACD For Traders
As a trader, the MACD is an integral tool to your trading exercise. This is because it helps you to both identify a trend and to tell how strong the price movement in the market is.
On the chart MACD chart of your trading platform, if the MACD line cuts through the signal line from below, this indicates to a trader that it is time to buy. If it cuts from above, it shows that it is time to sell.
A simple and straightforward indicator that is easily observed and can also be easy to follow.
As a trader, you can also use the MACD when there is divergence. Divergence shows the likelihood of the market reversing. However, many traders don’t trust the divergence to the presence of several false indicators.
Another way that traders can benefit from the MACD is to identify extreme values on the MACD. When these are present, they indicate the likelihood of a reversal in the market. This means a change in the price of a currency pair. If the price was moving upwards, there is a likelihood that it will start a downward trend.
Used with other tools, the MACD is often the one you will use to confirm that the other signals are correct. You can use it as a trend filter to indicate to you the best points to enter a trade or the market.
Pros Of Using The MACD
There are many advantages to using the MACD as a technical analysis tool. First, it is easy to use. Once plotted on your trading tool, you can clearly see how the graph is moving. This means that you can interpret it easily and quickly.
It acts to identify support and resistance levels and also to show the trend in the market. A trader can use it for more than one indicator or purpose of trade. You can use it to identify market entry points and also to predict the direction in which the market is moving.
Cons Of Using The MACD
The major disadvantage of the MACD comes when you decide to trade the MACD divergence. It contains numerous false signals and also there are no rules on how to trade the divergence. Making the MACD quite subjective as different traders will interpret it differently.
Conclusion
The MACD is an integral technical analysis tool that every trader should learn how to use. It is both a momentum and trend indicator. It helps traders to analyze the market effectively and get ideal entry points. It is an essential trading tool. As a trader, you need to learn and understand how to use and interpret it effectively to profit both in the short and the long term.