The MACD is a popular indicator among traders, used for forex trading and day trading. MACD stands for Moving Average Convergence Divergence.
Traders use the indicator to follow and establish trends showing the relationship between two price-moving averages.
Important to note also is that MACD is a lagging indicator, meaning it changes after an event in the market. Like most trading indicators, you can change the MACD settings to varying periods, as much as most traders prefer working with the default settings.
How MACD Works
The MACD indicator features three components:
1. The MACD Line displays the variance of the moving averages.
2. The Signal Line. This is a MACD line moving average.
3. The Histogram. The histogram shows the variance of the two moving averages.
The indicator essentially has two components, the signal and MACD line. MACD line is the slower main line, whereas the signal line is faster.
When the two lines come together, it is considered a convergence. When they are shifting away from each other, it is a divergence. The variance in the two moving averages is displayed on a histogram.
Sometimes, the MACD line budges atop the zero line, signaling an uptrend. A downtrend is established when the MACD line moves underneath the zero line. Traders use these indicators to determine when to enter short and long positions.
For instance, during an uptrend, the prices reach higher lows and higher highs, breaking the resistance levels; traders take it as a signal to enter long positions. On the other hand, during a downtrend, the prices reach lower lows and lower highs, breaking support levels, and traders enter short positions.
MACD Trading Strategies
Here are four key trading strategies you could employ using the MACD.
1. MACD Histogram
The histogram shows the variance of the moving averages. It features bars that display the variance. Note that the histogram increases in height when there is aggressive price movement in a single direction.
The histogram’s height reduces when there is slow market movement. When the lines move further apart, the histogram bars extend, moving away from zero.
2. The Relative Vigor Index (RVI)
The Relative Vigor Index compares a stock’s price range to the closing price and is an oscillator. Traders use the oscillator to understand oversold and overbought market conditions. Using the RVI, they can point out when a trend’s strength or momentum is solid.
Combining MACD and RVI is to match crosses to identify when to go long or short. Essentially, traders will use RVI to establish when to enter long or short positions and use the MACD indicator to confirm that they should go ahead.
This means the trader waits for the other indicator to cross in the same direction when one indicator has a cross. When this happens, they take a position. Traders look for the first cross from the RVI oscillator and wait for the MACD indicator to move.
3. Money Flow Index (MFI)
Money Flow Index is also an oscillator used for MACD trading. MFI focuses on both the volume and price and, as a result, generates fewer signals compared to other oscillators like RVI. It requires movements in both volume and prices to create extreme signals, which will generate fewer signals within a given time than other oscillators.
Using this strategy, traders combine crossovers of oversold/overbought signals from the Money Flow Index and MACD stock indicator. When traders get Overbought signals from the MFI, they hold back for a MACD bearish crossover. If it takes place, they enter short positions.
Likewise, they enter long positions when they get oversold signals from MFI and bullish signals from MACD.
The two moving averages of MACD can be utilized as the stochastic oscillator. Traders can use crossovers of the signal and MACD lines to identify sell and buy signals.
You get a buy indicator when the MACD line budges beyond the signal line. Conversely, bearish sell signals are created when the MACD line crosses below the signal line.
Traders need to note that the crossover strategy is lagging. This means they must wait for the movement to occur before entering a position. The crossover strategy is challenging to use during weak market movements as the prices could reach reversal points before the signals are created, creating false signals.
You can use several strategies to trade using the MACD indicator. They include crossovers, histogram, money flow index, and relative vigor index strategies.
When choosing a strategy for forex and day trading, it is essential to assess the drawbacks of the individual strategies. False signals may appear daunting to use in the beginning. However, it takes education and experience to understand the MACD indicator. It is crucial to put the strategies to the test with a simulator before using them on real money.