Hello and Welcome to the ditto educational series that will provide you with the skills you need to become a forex trader!
Today we will be discussing the lagging indicator known as the MACD and some of its properties including Histograms in order to show you this indicators potential at offering multiple signals to determine market direction within one indicator.
Before we can look in to the properties such as the histogram let’s first look at what a MACD is. MACD is short for moving average convergence divergence. It is a technical indicator that is used to measure price within the Forex market. It was created by Gerald lapel in the late 1970s. It can help us reveal changes in strength Direction momentum and duration of trend in the markets price. The MACD is an oscillator which is made up of three time series calculated from historical data.
Here we have added some moving averages to our chart. We have a 26 day exponential moving average and a 12 day exponential moving average. The MACD line is basically the difference between the two averages charted as an oscillator. We can see here the correlation between the exponential moving averages and the MACD line as the moving averages increase the MACD line also increases.
Now note here where the exponential moving averages cross each other the MACD line simultaneously dips below the zero line and then as the moving averages cross again and the MACD line rises back over the zero line the market rises back up. This in itself can be a good signal that the market is about to change direction and we are looking for buying opportunities when the line rises above the zero line.
If now we add A nine day exponential moving average line to our MACD, we have now created a signal line. We are looking for sell opportunities when they cross at the top and buy opportunities when they cross at the bottom.
Now histograms measure the distance between the MACD line and the new signal line that we have added. When the MACD line goes below the signal line you will notice that the histograms turn negative. Sell signals represent as negative and by signals represent as positive in accordance with the histograms.
Notice how when the MACD line swings toward The signal line we start to see an uptrend on the negative histograms as they reduce in size, when the MACD line crosses the signal line this is a bullish signal, when the histograms turn positive this is also a bullish signal. These two signals together would indicate a buy to us.
As the MACD line and signal line gets closer to one another and you will also notice the histograms narrowing, we should be aware that a potential buy or sell could be upcoming and depending on your trading style be ready to trade it. Remember that unless the MACD line crosses the signal line we remain bullish or bearish until the lines cross.
This all may sound confusing at first but let’s simplify it by saying that if our histograms are above the signal line then we are bullish as they grow shorter almost to the point of the Signal line we are fairly neutral and when they cross below we are now bearish.
Of course we would like to use this indicator in conjunction with sound risk management and a solid overall trading strategy, we say this all the time but there is no such thing as a standalone indicator. Using the MACD to trade in the direction of strong trend can increase your win rate as opposing the trend is never a good idea.
Could we however use the MACD to measure momentum and point out reversals to us. As we already know we look for buying opportunities near prominent support and selling opportunities near prominent resistance. What are the sort of things we would like to see on the MACD indicator in accordance with trading opportunities when it comes to reversals?
When we see aggressive or strong histograms building momentum as the market is approaching support or resistance, in this case we see strong Bearish candles pushing down and our negative histograms are gaining more and more strength consecutively, This could be a strong opportunity where we are looking to buy the market.
This seems counterintuitive but the reason for this is that strong momentum is usually thought of as a better trade set up than a gradual or weak momentum lead up when approaching support or resistance. When we have strong momentum with little to no opposition the market can easily collapse in the opposite direction when it needs support or resistance due to the closing of open trades and the imbalance of selling pressure in this case being rectified.
Of course we will want to use entry triggers such as candlestick formations to confirm a reversal but strong and continually growing histogram bars are a good sign when we are approaching support and resistance levels.
In conclusion the MACD is a very versatile technical oscillator that can help us uncover buying and selling opportunities. It is especially useful as an additional confirmation when u