MACD Indicator - 4 Trading Strategy Signals
Every trader sooner or later begins to experiment with technical indicators, trying to find "the one" which will allow opening deals with at least 100% profitability. Often, the result of such investigations becomes a chart, riddled with signals of all kinds of "super-profitable" indicators so much that it resembles the paintings of abstractionists.
The best is the enemy of the good and, unfortunately, many classical indicators are becoming forgotten, although their effectiveness is not inferior, and sometimes even superior to all gals. Today we will talk about one of such indicators, namely MACD.
MACD - indicator for beginners
The MACD indicator is an acronym that stands for Moving Average Convergence Divergence, which translates as Moving Average Divergence. Its name is pronounced correctly as "M ACD", although in the Russian-speaking segment you can find the slang name "Makdi". The MACD indicator was invented in 1979 by trader Gerald Appel for trading on the stock market, and then, like many other indicators, moved to the foreign exchange market.
The MACD is a unique indicator because it combines the qualities of a trend indicator and an oscillator. It can be used to determine the further direction of the price, the potential strength of the price movement, as well as the points of possible trend reversal.
The use of moving averages in the indicator and smoothing of the received signals determined the presence of the signal lag, which is typical for trend indicators. This can hardly be considered a significant disadvantage. For scalping - This is certainly bad for trend trading, on the contrary, because it allows to filter out noises and false movements.
Along with this, the MACD is a leading indicator, which is inherent to oscillators, and allows you to determine in advance the price reversal points.
Another very important point is indicator MACD would be perfect for for novice traders. The qualities of the trend indicator will not allow a beginner to trade against the trend, and the qualities of the leading oscillator will give an opportunity to open a deal at the very beginning of the trend and close the deal at the moment of its end.
How to install the MACD indicator on the chart?
MACD is a standard indicator of the MetaTrader 4 platform. To install it, go to the "Insert - Indicators - Oscillators - MACD" tab.
After that the indicator settings window will appear. We will leave the default settings for now and return to them a little later for a detailed breakdown.
As a result, we get the MACD indicator on the chart in the following form.
Indicator parameters
Let's take a closer look at the MACD indicator parameters. As you can see from Figure 2, in order to configure the indicator you need to specify the periods for the three moving averages and the price at which they are to be plotted.
A fair question arises: if only moving averages are specified in the indicator parameters, then Where do those blue posts in the basement come from? This is the essence of the MACD indicator. To understand this, let's put two exponential moving average EMAs with the same periods as the MACD, i.e., 12 and 26.
As can be seen in Figure 4, the height of the histogram bar corresponds to the distance between EMA 12 and EMA 26. At that, if the faster moving average (EMA 12 in our case) is higher than the slower one (EMA 26), then the bars of the histogram will be above the MACD zero line. Otherwise, the histogram bars will be below the zero line.
When two moving averages cross, the MACD indicator histogram will react by crossing the zero line from positive to negative and vice versa. This is why the indicator is called the Converging Moving Average Divergence.
Where does the red dotted line come from? This line is sometimes called a signal line. There is a misconception that this moving average smoothes the price. In fact, this line is the average value of the histogram. That is, the last closing prices of bars (9 by default) are taken and their average value is calculated.
How to set MACD parameters correctly?
By default, we get a MACD indicator with parameters 12, 26 and 9. By changing these parameters, we can adjust the indicator's reaction speed to price changes and the frequency of trade signals. We will consider two options - increasing and decreasing the parameters.
- Increase the MACD indicator parameters
By increasing the parameters, the MACD indicator will give trading signals less frequently, and will filter out false signals. However, this will sometimes cause the indicator not to react to the start of some potentially profitable price movements.
- Reducing the MACD indicator parameters
When you reduce the parameters, there will be the opposite effect. The indicator will become more sensitive to price movements, trade signals will appear more often, however, and the number of false signals will increase.
What trading signals gives the MACD indicator?
Now it's time to get to the most important part. what trading signals the indicator will give us MACD. So, the MACD can give four basic trading signals.
Determining the direction and strength of the trend
If the histogram is above the zero line and the maximums of the histogram bars are consistently rising, the market has an uptrend. Correspondingly, the mirror situation takes place for the downtrend. This method of determining the trend on periods Daily and older was proposed by Alexander Elder in the "Three Screens" strategy.
In addition, this method allows you to estimate the strength of the trend. The logic of the process is simple. The greater the distance between the moving averages, the higher the bar graph, and therefore the trend is more stable.
2. local minima and maxima of the histogram
The formation of local minimums and maximums on the histogram indicates that the price begins to correction or reversal. Note that a price reversal cannot be determined by the readings of only one indicator, it must be confirmed by other signs as well.
3. MACD crossing with the zero line
As we wrote above, the histogram crossing the zero level corresponds to the crossing of the moving averages, which in classic trading is interpreted as a signal to enter the market.
That is, if the MACD histogram crosses the zero level downwards it is a sell signal, if it crosses it upwards it is a buy signal.
It is worth noting a very important point. There is no unequivocal opinion among traders. Some consider this trading signal to be the strongest one that can be obtained from MACD. Some traders claim that trading on a moving average crossing is complete nonsense. We believe that this method will only work with the right choice of indicator parameters and the timeframe used in addition to confirmation from other indicators.
4. the use of divergences
Divergence on is divergence between the price direction and the indicator direction, which is interpreted as a prerequisite for a soon reversal of the trend.
In the case of the MACD, divergence is defined between price directions and consecutively rising or falling histogram bars. Note that histogram peaks only count above or only below the zero level. When the histogram crosses the zero line, the divergence is considered to be unloaded.
Does MACD have disadvantages?
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All technical indicators have disadvantages. MACD has not become an exception. The main disadvantage is the use of moving averages, which leads to delayed signals, as well as to a lot of false signals in flat movements.
Not the disadvantages, but rather the nuances, can be attributed to the fact that the classic MACD is designed for the analysis of the timeframes of a day or more. By the way, few people know about it, the default indicator parameters (12, 26, 9) are initially designed for the daily chart. Of course, nobody forbids to use MACD on smaller timeframes, but the quality of signals will "suffer". Accordingly, the MACD indicator must be adjusted for each used timeframe and currency pair.
So, should I use the MACD indicator in trading?
In spite of its relative "antiquity", the MACD indicator is still relevant and is used in many trend-following strategies. In addition, the MACD itself has served as a basis for the creation of more advanced modifications with increased efficiency.
MACD indicator is rightfully considered a "deserved veteran" of the currency market. Understanding the principles of its work will be the key to making a profit in trading even for a beginner trader.