It is almost safe to say that the MACD Technical Indicator is the most popular indicator in Forex Trading right after Bollinger Bands. It was created by Gerald Appel, author of the popular book “Technical Analysis: Power Tools for Active Investors”.
MACD is widely used partly because it is very simple to calculate (important back in the days without computers) and the reliability of the signals. It is understandable that MACD often is used in program trading and High Frequent Trading as it has proved useful on many different market conditions and different time frames.
MACD – Moving Averages Convergence Divergence uses two moving averages (default EMA:Exponential Moving Average) as the key component in the calculation of indicator. Subtract the longer EMA from the shorter EMA and you get a line that moves up and down the value 0. When MACD crosses 0 it means the EMAs are crossing over each other. The line represents the gap between the two EMAs which is the same as momentum.
When one EMA accelerates away from the other it shows momentum. The default settings are a 26 and 12 EMA but you can chose whatever length you want. A shorter EMA will give you a quicker signal but also more fake signals. A longer EMA will lag price more but give fewer fake signals. In most cases a 9 EMA is plotted along side the MACD line to give the trader a quicker entry signal then the crossover of the two EMAs (MACD line crosses 0). So instead of using the MACD line cross of 0 many traders uses the MACD line cross of 9 EMA as the signal.
Furthermore you will often find a histogram which represent the difference between the MACD line and the 9 EMA. When the MACD is above the 9 EMA the histogram is above 0 and when MACD is below the 9 EMA the histogram will be below 0. A MACD above 0 simply tells the you in a easy visual way that the 12 EMA is above the 26 EMA.
This tells the trader that the trend is up. If the MACD is above 0 but declining it tells us that the trend is up but the momentum (gap between 26 and 12 EMA is getting smaller) to the upside is decreasing. This is a warning sign telling the trader that a trend change might occur soon. A MACD below 0 tells you that 12 EMA is below 26 EMA and that the trend is down and so on. You now know the MACD tells us about trend and the momentum in that trend.
You also know when to enter, either using the MACD line crossing 0 or the MACD line crossing 9 EMA. But like any other indicator the trader can apply filters to improve his/her trading.1) Trend Trading The MACD tells us the trend but only the short term trend (as MACD only uses a 26 and a 12 EMA) so by using a longer term EMA or MA the trader can filter out trades that is not in alignment with the longer term trend. So for example if the longer term EMA or MA is up sloping then tou will only take long signal (MACD line crossing up through either 0 or the 9 EMA). MACD Trend Trading2) MACD Divergence Another method used to increase the odds of success is by using divergence.
You will only take a MACD cross if this occurs right after a divergence. For example when MACD crosses up through 0 after making a higher low while price making a lower low. This divergence can signal a stronger bounce as the new low in price is not confirmed by the MACD indicator. MACD Divergence3) MACD Histogram Divergence on histogram is a third option. Similar to the above mentioned example but in this case the divergence shows up on the histogram. The divergence in this case shows that the momentum (difference between MACD line and 9 EMA) is less on the current move vs the previous move. This means the selling pressure on the new low in price is less than prior low.