Day Trade with Moving Average Convergence Divergence

In the past few months, we have been on a journey to educate our members on technical analysis.

It is a journey that has seen us cover some of the most popular indicators like the Relative Strength Index and other unpopular indicators like the Donchian Channel.

In this article, we will look at another popular indicator known as the MACD and how to use it in trading.

What is the MACD Indicator?

The Moving Average Convergence/Divergence (MACD) is an indicator that was developed by Gerald Appel in the 1970s. The indicator is found in most trading software like the MetaTrader  in the oscillators category.

When applied in a trading chart, the MACD is has two lines. The first line is usually the signal line while the other one is the main line. In other platforms, the main line is usually seen as a histogram.

As the name suggests, the MACD is derived from moving averages. The moving average is one of the most common indicators in the world. It has also been used to create other indicators.

For example, the Bollinger Bands, an indicator we have covered before, has been developed using moving averages and standard deviation.

The Moving Average Convergence-Divergence indicator is a simple indicator that is developed by combining two moving averages and subtracting the longer one from the shorter one.

By doing this, the MACD forms a momentum oscillator from two trend indicators.

How to Calculate it

As mentioned above, the MACD is calculated by first calculating the moving averages. As we have covered before, there are several types of moving averages. There are the simple, exponential, weighted, and smoothed moving averages.

In this case, the type of moving average that is used is the exponential average. This is because the EMA is usually weighted more towards the last closing price. As such, it tends to be more accurate than the simple moving average.

Therefore, the MACD is calculated using the following method.

  • MACD Line = (12-day EMA – 26-day EMA)
  • Signal Line = 9-day EMA of MACD
  • Main Line = MACD line – Signal Line

The 9-day, 12-day and 26-day EMA are usually the default in most platforms. However, you can always tweak the periods depending on your trading strategy.

The MACD explained: settings for day trading

The name tells it. The MACD stands for moving average convergence and divergence. As such, its goal is to find where the long-term and short-term moving averages converge and diverge.

Convergence is when the two averages move towards one another while divergence is when the averages move away from one another.

Another thing. When applied on a chart, the main line of the MACD oscillates above and below the centreline.

As such, a signal of the MACD indicator usually happens in three ways:

  1. It happens when the main line and the signal line of the MACD crosses the centreline.
  2. A signal happens when the two lines make a crossover
  3. It usually happens when the two lines are in extreme areas.

How to read and use the Moving Average Convergence Divergence

To use the MACD well, there are a few things you need to do.

First, ensure that the chart you are using is not in consolidating mode. A chart that is consolidating or moving in a sideways direction is not recommended. This is simply because when this happens, the short and long-term moving averages are usually the same.

As such, there will be no significant divergence or convergence.

Second, ensure that you check the inputs in the MACD. In most cases, the default inputs are 9, 12, and 26.

A good example of the MACD indicator at work is shown on the NZD/USD chart below. On this chart, look at the red and blue trend lines.

MACD on NZD-USD chart

Convergence-Divergence on NZD-USD chart

As you can see, a sell signal is usually indicated when the two lines are moving downwards while a buy signal usually emerges when the two lines are moving upwards. The most important period is when a crossover between the two lines happen.

Summary

The MACD is one of the most popular technical indicators in the financial market today. It is also one of the easiest to calculate and use.

In this report, we have looked at who developed the indicator, how it is calculated, and how it is used in the financial market. We could have written a lot and shown examples of the indicator.

If you are just getting started using it, we recommend that you take your time to read more about it.

Also, we recommend that you take your time to use the indicator in the demo account.

External Useful Resources

  • Accuracy of MACD divergence for trading – The Balance
  • How to Interpret the MACD on a Trading Chart – Dummies

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