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MACD? How to trade it?

Moving Average Convergence/Divergence (MACD) is type of indicator that is said to be the simplest and most reliable that has ever been formulated. It is formulated by Gerald Appel and it uses the theory of moving averages to be able to determine some characteristics that can greatly result in possible trends. It then forms a plot that sways not very far above and below zero creating the impression of a centered oscillator. Because of that, the rule for centered oscillators also applies in interpreting the results of a MACD indicator.

The main purpose of MACD is to measure the difference two exponential moving averages or EMAs. It does this by using a formula that is used many technical analysis programs and books. The two EMAs to be included are the 12 – day EMA which shows a faster and more responsive securities and the 26 – day EMA which is made of a slower security. The closing prices of currencies are then determined to serve as the moving averages. Oftentimes a trigger line is also plotted which is composed of a 9 – day EMA. This is then used to determine other signals like Bullish Crossover ones.

A positive EMA usually means that the 12 – day EMA is trading above the 26 – day EMA. If it shows a continued positive rate of increase, the gap then quickly widens. It just means that a bullish period of trading is occurring. On the other hand, it shows a negative rate of increase when the gap continuously expands. This is because a negative increase usually means that the 12 – day EMA is trading below the 26 – day EMA. This usually means a bearish period of trading.

Signals that are created in a Bullish period of trading are usually derived from three sources that is the positive divergence, Bullish Moving Average Crossover and the Bullish Centerline Crossover. Traders use one or even a combination of these signals in order to buy or sell. This is also applicable to signals that are created in a Bearish period of trading. They are basically the same as Bullish signals except that they are negative.
MACD divergencies can be uses in predicting a change in trend. An example of this occurs when a negative trend is seen and Bullish signals are expected to occur. This serves as a sign for traders to take advantage of longer currency positions or to consider starting a shorter position. Aside from that, MACD divergences can also be applied to daily, weekly or monthly charts. This can then be adjusted depending on a trader’s style and objectives.

Even though it is simple and reliable, it usually shows data that are lagging and delayed. This is not particularly good especially in identifying levels that are either overbought or oversold. It may be possible, but MACD don’t have any limits to bind its movement. Also, MACD levels are difficult to compare for a longer period of time especially if the difference between the two moving averages is starting to grow.

Even though there other indicators that have appeared that are also used for technical analysis, the MACD is still used widely because of its reliability and simplicity.