Using the MACD Indicator to Make Trading Decisions
Technical analysis is used by traders in the stock, commodities and Forex markets, for example, to help predict upcoming market directional changes. Trading charts relating to just about any market can be found online. The MACD technical analysis indicator can be added to these charts over selected time periods to help traders make buy and sell decisions. Traders interested in taking out longer term trades will look at the MACD indicator movement over the course of days, or weeks, while shorter term traders study how it is performing over hours, or minutes. Trading charts depict price changes over time.
What is the MACD?
Moving averages, or MAs, are line representations (which can be brought up on these charts) to show how the average price has altered over any particular time period. Exponential moving averages, or EMAs, apply more importance to recent price moves and are thought to more accurately predict represent price movement than the more simple MAs. The MACD indicator is based on EMAs.
In simple terms, the MACD smoothes out the market information to show how the price is trending. It is considered to be a lagging indicator, as it is based on historical data, but is nevertheless popular with traders making buy and sell decisions.
How is the MACD Used to Help Make Trading Decisions?
The MACD indicator can be used to make buy and sell decisions in 3 ways:
1. Buy or sell signals are taken from the MACD when its signal line crosses above or below the indicator line. The two lines are shown in different colors and follow each other fairly closely, crossing over at different points, often as the market is changing direction. Simple buy signals occur when the signal line crosses above the indicator line and vice versa.
2. The MACD also has positive and negative values showing on the side of it and some traders take buy and sell decisions when the MACD indicator crosses above or below the zero line respectively.
3. Another way the market is shown on the MACD indicator is on its histogram. This shows the up and down movement of the market with lines forming a wavy block pattern above and below the zero line. When there is a divergence in the direction of the histogram compared to the price movement on the trading chart, i.e. when they are going in opposite directions, traders take it as a sign that the market is changing direction.
The MACD, like most indicators, often generates false buy and sell signals, and it is wise to use it in conjunction with at least one other indicator. Sometimes it is used as confirmation of trading decisions made using other methods. Traders often look at emerging patterns in the price data which are thought to predict upcoming changes in market direction. Having identified what they think is an upcoming change in the market trend they will look to the MACD for added confirmation before making a final trading decision.
Using the MACD indicator can help you make trading decisions, but no trading strategy is guaranteed and lots of traders lose money. Demonstration trading accounts are available from many brokers which are useful for practicing trading strategies before any real money is risked.