Moving Average Convergence Divergence (MACD) was developed by Gerald Appel in the late 1970s. He later published details about this indicator through his book named ‘The Moving Average Convergence Divergence Trading Method’. Currently, MACD is widely used as a reliable trading indicator by millions of traders is the financial markets around the world. Moreover, its simplicity of use and easy chart demonstrations offer a great advantage for the newbie traders in the market.
What is MACD?
MACD is well known as a momentum indicator, especially used for forex trading purposes. It measures the distance between two different moving averages and also defines the crossovers which signal the strength or weakness of the market momentum. MACD can also be applied to spot possible trend reversals of the market.
How to set up MACD on Metatrader 4 or 5?
MACD is always preinstalled in Metatrader4 (MT4) and doesn’t require any installation. You’re only required to follow a simple process to apply it on the trading charts:
- Go to Insert menu, click on the Oscillators, and select MACD
- You’ll see a setup dialogue box as below:
- Value setups: Fast EMA = 12, Slow EMA = 26, MACD SMA = 9, and Apply to = Close (by default)
- Click ‘OK’ and find MACD on your chart as the image below:
MACD is combined with three major components:
- 9-day Simple Moving Average (SMA)
- 12-day Exponential Moving Average – EMA (fast)
- 26-day Exponential Moving Average – EMA (Slow)
9-day SMA directly appears as the Signal Line. On the other hand, MACD bars are created with a combination of 12 and 26-day EMAs.
- MACD Bars: It is used to identify the market momentum. MACD bars move above the zero level means the momentum is turning bullish. Oppositely, the bars go down below zero levels represents the bearish momentum of the market.
- Signal Line: It works as a filter of the signals generated by the MACD bars. Signal line value turns positive is considered as the confirmation of the bullish momentum and for the validity of the bearish momentum, its value must be turned as negative. It moves slower than MACD bars but offers greater confirmations of the market momentum directions.
There are many other ways to apply MACD tools in order to define the momentum, overbought/oversold conditions, and possible strength of current market trends. We’ll discuss these methods and demonstrate the different uses of MACD throughout this article.
How to trade with the MACD
Buying in bullish momentum
Besides currency pairs, MACD is also used to trade the Cryptocurrencies. This is ETH/EUR (Ethereum vs Euro) hourly chart. For buy setup, you’ll have to wait until both MACD bars and the signal line move above the zero levels or turn positive in value. Besides, for better confirmation, you may look for a solid bullish candle at the same time and trigger the buy entry at the break of the respective bullish bar’s high.
You can set the stop-loss limit right below the current low of the market. A rising trend in MACD value indicates a better strength of the bullish momentum. MACD can also be used to determine the trade exit levels. MACD bars start to close below the signal line and the value keeps decreasing means it’s time to consider the profit taking/trade exit.
Selling in bearish momentum
For sell setups, it is necessary to be confirmed about the bearish status of the current momentum. In such a case, you’ll need to wait until MACD value turns negative. Both MACD bars and the signal line should represent negative values in a decreasing pattern. A bearish bar appears at the same time means a greater confirmation to go for a short position. MACD bars start to close above the signal line is considered as the exit signal of the sell entry.
Trading divergence is another popular method of using MACD bars. A divergence occurs when MACD bars behave quite opposite to the price action movements. There are two kinds of divergences:
- Bullish divergence
- Bearish divergence
Bullish divergence happens when the MACD bars create a higher low and price bars create a lower low at the same time. A bullish divergence also represents the ultimate oversold condition of the market. MACD values are not so important in case of divergence trading, you only need a complete shape of the divergence. Bullish divergence represents a strong possibility of the price hike thus, considered as a buying opportunity in the market. We recommend setting a stop loss right below the current lower low of the market while buying based on bullish divergences.
A bearish divergence occurs when price makes a higher high but MACD bars create a lower high at the same time. Most of the time we encounter bearish rallies of the price as an aftermath of bearish divergences. Therefore, a bearish divergence represents the selling opportunity in the market. For any sell entry based on the bearish divergences, the stop loss limit should be set above the current higher high of the market.
Trading divergence is tricky but very much reliable as a trading strategy. It spots the hidden intention of the price movements which you cannot see in naked eyes. When price makes a higher high, you might consider the situation as a buying opportunity expecting a further price hike. Although, you’ll certainly not do so if you notice a bearish divergence is taking place in the background which is going to switch the current bullish momentum into bearish.
MACD is considered as the simplest but most reliable momentum-based trading indicator in the financial markets. It suits well with all kinds of timeframe charts within the MT4 trading platform and can also be applied to trade all kinds of currency pairs including other financial assets.
Compared to other trend-following indicators, MACD is quite easier to understand and simpler to apply for trading purposes. Despite being a stand-alone indicator, MACD can still be added to other trend or momentum-based trading indicators or strategies for enhancing trading results.