Today’s lesson will look at an indicator which is based on moving averages which is known as the Moving Average Convergence/Divergence. So let’s get started.
One of the advantages of using the MACD indicator instead of the moving averages is that the MACD gives you an indication not only of what’s happening with trends in the market but also what’s happening with momentum, so you’re given an addition to the picture there that this indicator paints for you. The indicator is constructed by taking a 12-period exponential moving average of a financial instrument and subtracting its 26-period exponential moving average. The resulting line is then plotted below the price chart and fluctuates above and below a center line which is placed at value zero. A nine-period exponential moving average of that MACD line is normally plotted along with the line and is used as a signal of potential trading opportunities which we are going to look at in our next lessons.
Look at what this looks like on a chart. You can see here the MACD below the price chart and you can see here the black line is the MACD line and the blue line is the nine-period exponential moving average of that black MACD line which is the signal line. OK.
Now, when the MACD line is above zero this tells the trader that the 12-period exponential moving average is trading above the 26-period exponential moving average and when the MACD line is below zero this tells the trader that the 12-period exponential moving average is below the 26-period exponential moving average.
So that it is the simplest, the first thing that this is, is an easier way to look at a moving average crossover system. Traders are going to watch the MACD line and when it’s above zero and rising, they’re going to look at this as a sign of positive bullish momentum in the market as the gap, the positive gap, between the exponential moving averages is widening.
When it’s below zero and falling, they’re going to look at this as a bearish sign for the market as this indicates that the negative gap between the two moving averages is widening. So you can see here the MACD line is above zero and rising and that is bullish and you can see here it is below zero and falling and that is bearish, so it did play out there for us.
The purpose of the nine-period exponential moving average is to further confirm the bullish changes in momentum when the MACD crosses above the zero line and the bearish changes in momentum when the MACD crosses below the zero line. You can see here the MACD crossing above the signal line is further confirmation that there’s a bullish momentum in the market.
You can see here it crossing below and it actually crosses below at the top peak of the market there and that was a bearish sign and that was a very good signal that this particular indicator caught to the bearish side because the market did sell off after that. Lastly, mini-traders and charting packages will plot a histogram along with the MACD which is representative of the distance between the MACD and its signal line.
When the MACD histogram is above the zero line, this is an indication that positive momentum is increasing. Conversely, when the MACD histogram is below the zero line, this is an indication that the negative momentum is increasing. OK.
You should now have a good understanding of the different components of the MACD and in our next lesson we’re going to look at exactly how you can use some of the signals that this indicator generates in your trading and how you can use those actually to place trades and how you can actually use the indicator to get it a feel for direction in the market and momentum in the market.
How to trade the Moving Average Convergence Divergence (MACD) in the stock, futures, and forex markets. The indicator, which was developed by Gerald Appel, is constructed by taking a 12 period exponential moving average of a financial instrument and subtracting its 26 period exponential moving average.
The resulting line is then plotted below the price chart and fluctuates above and below a center line which is placed at value zero. A 9 period EMA of the MACD line is normally plotted along with the MACD line and used as a signal of potential trading opportunities in the stock, futures and forex markets. When the MACD line is above zero this tells the trader that the 12 period exponential moving average is trading above the 26 period exponential moving averages.
When the MACD line is below zero this tells the trader that the 12 period exponential moving average is below the 26 period exponential moving average. Traders will watch the MACD line as when it is above zero and rising this is a sign that the positive gap between the 12 and 26 EMA’s is widening, a sign of increasing bullish momentum in the financial instrument they are analyzing.
Conversely when the MACD line is below zero and falling this represents a widening in the negative gap between the 12 and 26 day EMA’s, a sign of increasing bearish momentum in the financial instrument they are analyzing.
See Trade the MACD Indicator Like a Pro Part 2 >>