how-to-use-macd-indicator

The MACD indicator is a widely used tool by Forex traders. 

In this article, I will help you know this indicator in depth. 

It will not be the usual MACD indicator stuff that you read in textbooks. 

You’ll realize that you should not trade the MACD in isolation. 

To use this indicator successfully, it must complement the price action of the markets. 

You’re now asking yourself…

“So, how do I do it?”

That’s what I am about to show you!

Let’s get started…

What is MACD Indicator?

The Moving Average Convergence Divergence (MACD) calculation is an indicator for following trends. 

It falls into the group of lagging indicators. 

The basic purpose of the MACD Forex indicator is to discover new trends and to identify the end of the current trends. 

There are different ways of gauging the signals generated by MACD. 

Each trader also uses his own unique settings and methods around this trading indicator. 

It is made up of two exponential moving averages and a histogram. 

To calculate the MACD, we use the following formula…

MACD Line: (12-day EMA – 26-day EMA)

Signal Line: 9-day EMA of MACD Line

MACD Histogram: MACD Line – Signal Line

The first part of the formula calculates the first moving average, the MACD Line. 

The second part of the formula calculates the second moving average, the Signal Line. 

And the third part of the formula calculates the Histogram.

I am sure it looks complex to you. 

But don’t run away. 

Let me explain what it means…

MACD Indicator Structure

As we stated earlier, each trader uses his own unique settings when using MACD. 

So, what is the best MACD settings?

The answer is, there is no best MACD settings because it doesn’t exist. 

So, feel free to use any MACD settings that you want. 

Remember, the indicator consists of two moving averages and a histogram. 

Let’s discuss them…

#1: MACD Line

The MACD Line is the faster line on the indicator. 

This line reacts faster and is more sensitive. 

Due to this, this line moves below and above the second line of the indicator. 

And it’s simple to calculate it…

You simply take the 12-day EMA (Exponential Moving Average) and subtract the 26-day EMA (Exponential Moving Average). 

The good thing is that you can get these values from your chart without doing even a single calculation. 

Consider the chart given below…

MACD-LINE

The above chart shows how to calculate the value of the MACD Line. 

The MACD Line is the blue line pointed by the red arrow. 

To calculate the value of this line, we had to take the value of the 12-day EMA and subtract the value of the 26-day EMA from it. 

The value of 12-day EMA is 66.8, while the value of 26-day EMA is 83.3. 

After subtraction, we got -16.5. 

This becomes the value of the MACD Line. 

This calculation has been shown on the chart. 

Note that the values for 12-day EMA and 26-day EMA are given on the chart. 

You can also get them manually from the scale running upwards on the left. 

Congratulations!

I told you it’s easy to calculate it!

Now you’ve seen yourself!

#2: The Signal Line

This is the second line of the MACD Forex indicator.

It is given the name Signal Line because it generates the basic MACD signals. 

Since this line is slower, it is frequently breached by the MACD Line. 

It’s easier to calculate the value of the Signal Line. 

You simply have to take the historical value of the MACD Line then you divide it by 9. 

The value that you get will be the Signal Line. 

Suppose you have a MACD Line of the following values…

2, 4, 6, 8, 9, 11, 12, 14, 17

The sum of the above numbers is 83. 

When we divide 83 by 9 we get 9.2. 

So, the value of the Signal Line is 9.2. 

Consider the following chart…

how-to-use-the-macd-indicator

The above chart shows the Signal Line. 

It is the line pointed to by a red arrow. 

It’s very clear that the MACD Line moves faster than the Signal Line. 

That’s why the MACD Line consistently breaches the Signal Line. 

You now know how to calculate the Signal Line. 

#3: MACD Histogram

The MACD Histogram marks the difference between the MACD Line and the Signal Line. 

If there is a big gap between the two lines, then the MACD Histogram will display large bars. 

The vice versa is also true. 

So, to calculate the value of the MACD Histogram, you take the value of the MACD Line and subtract the value of the Signal Line. 

Consider the following chart…

trading-with-macd-indicator

In the above chart, we have calculated the value of the MACD Histogram. 

We have simply taken the value of the MACD Line and subtracted the value of the Signal Line from it. 

The MACD Histogram are the bars pointed by the red arrow. 

Its value from the calculation is 75.7. 

The calculation has been shown clearly on the chart.

What you should have noticed is that the MACD Histogram moves in harmony with the distance between the two indicator lines. 

If the distance between the two indicator lines is small, the MACD Histogram displays small bars. 

If the distance between the two indicator lines is large, the MACD Histogram displays large bars. 

MACD Settings

So, most traders ask themselves this question…

“Which is the best MACD indicator settings?”

The answer is, there is no best MACD settings. 

Why?

Because the market keeps on changing. 

So, what works best for you now may not work in the future. 

Your goal should not be to optimize for the best settings because it doesn’t exist. 

Instead, you should understand how MACD works and use it to meet your trading needs. 

In most trading platforms, the MACD indicator comes with default parameters of 26, 12 and 9. 

The “12” and “26” are used for calculation of the MACD Line while the “9” is used for calculation of the Signal Line. 

MACD Signals

The MACD has only three components, the two lines and the histogram. 

However, this indicator can give traders a myriad of signals. 

So, let’s discuss the important signals provided by the indicator…

MACD Crossovers

The MACD Crossovers is the interaction between the two MACD lines. 

Since the MACD Line is faster than the Signal Line, it crosses below and above the slower Signal Line. 

A MACD Crossover can be bullish or bearish…

A bullish MACD Crossover occurs when the MACD Line crosses the Signal Line in a bullish direction. 

It creates a bullish signal on the chart, meaning that the price may begin to increase. 

A bearish MACD Crossover is the opposite of the bullish MACD Crossover. 

The bearish MACD Crossover occurs when the MACD Line crosses the Signal Line in a bearish direction. 

It sends the signal that the price might be beginning a bearish move. 

Consider the chart given below…

macd-crossover

The above chart shows the occurrence of both the bullish MACD Crossover and the Bearish MACD Crossover. 

The bullish MACD Crossover occurred when the MACD Line (the blue line) crossed the Signal Line in a bullish direction. 

The bearish MACD Crossover occurred when the MACD Line crossed the Signal Line in a bearish direction. 

When a bullish MACD Crossover occurs, the price increases. 

This is clearly shown in the chart using the red arrow marked as Price Increases. 

When a bearish MACD Crossover occurs, the price decreases. 

This has been shown on the chart using the red arrow marked as Price Decreases. 

What you must have noticed is that the price action is showing a very strong trend. 

However, you will later see something different about the MACD Crossover when the price action is showing a weak trend. 

Keep reading!

MACD Divergence

The MACD Divergence is highly used by Forex traders to identify divergence signals

When the direction of the general price action and the MACD direction contradict each other, it acts as an indication that the price is most likely to change direction. 

Also, the MACD Divergence can be bullish or bearish…

A Bullish MACD Divergence happens when the price action is moving downwards and the MACD is showing higher bottoms. 

Traders should use it as a signal of a strong bullish move. 

In most cases, the bullish MACD divergence is followed by a sharp increase in the price of the currency pair. 

Consider the following chart…

the-Macd-Divergence

The above chart shows the occurrence of a bullish MACD Divergence. 

The region in the price action where this occurs has been shown using a blue line marked Bullish MACD Divergence. 

Although the price action is in a sharp downtrend, the MACD is shown higher bottoms. 

This is followed by a sharp rise in the price. 

This has been shown using a red arrow marked as Price Increases. 

So, a bullish MACD Divergence acts as a signal that the price is about to increase. 

A Bearish MACD Divergence happens when the price action is in a bullish trend but the MACD lines are showing lower tops. 

It acts as a signal that the price action might be beginning a bearish move soon. 

In most cases, the bearish MACD Divergence is followed by a sharp bearish trend. 

Consider the chart given below…

how-to-trade-macd-divergence

The above chart shows the region where a bearish MACD divergence occurs. 

This is the region shown with a blue line marked as Bearish MACD Divergence. 

The price action in this region is in a bullish trend. 

However, the MACD lines are simply showing lower tops. 

The bullish price action is then followed by a sharp decrease in the price of the currency pair. 

This has been shown using the red arrow marked as Price Decreases. 

So, a bearish MACD divergence is normally followed by a bearish trend. 

MACD Overbought/Oversold

The MACD provides traders with overbought/oversold signals. 

However, most traders don’t know this.

So, what are they?

The MACD is said to be overbought when the MACD Line gains a relatively big bullish distance from the Signal Line. 

In such cases, you should expect the bullish move to end after a sharp increase in price and a bearish move should begin. 

Consider the chart given below…

trading-macd-overbought

The above chart shows how an overbought MACD is formed. 

The MACD Line creates a big bullish distance from the Signal Line. 

When it reached its peak, the price begun to decrease. 

This is shown by the red arrow marked as Price Decreases. 

So, an overbought MACD is followed by a decrease in the price of the currency pair. 

An oversold MACD is the opposite of overbought MACD.

It is formed when the MACD Line gains a relatively big bearish distance from the Signal Line. 

In such a case, the price action is expected to end its bearish move and begin a new bullish move. 

Consider the chart given below…

mace-oversold-trading

The above chart shows how an oversold MACD is formed. 

The MACD Line forms a significantly large bearish distance from the Signal Line. 

Note that this occurs during a downtrend as shown by the price action. 

After the oversold position, a major price increase occurred. 

This has been shown using the red arrow marked as Price Increases. 

This means that an oversold MACD is a signal that a bullish trend is about to begin. 

Common Mistakes when using the MACD Indicator

Let me share with you the 2 common mistakes that traders make when using the MACD indicator…

#1: Always Trading the MACD Crossover 

Do you remember what a MACD Crossover is?

We discussed the two types of MACD crossovers, bullish and bearish MACD crossovers. 

They send a signal of a possible trend reversal. 

However, you should only trade them when the price action is showing a strong trend. 

If the trend is weak, it won’t work for you. 

The reason is that the market stays in a range in most cases. 

So, it’s possible for a MACD Crossover to give traders a false signal. 

Consider the following chart…

macd-croosover-signals

The above chart shows instances at which the MACD crossover sends a false signal to the traders. 

A bullish MACD crossover sends a signal of a potential price increase. 

In the above chart, the price increased by a very small margin after bullish MACD crossovers. 

This is also the case with bearish MACD crossovers. 

Although they send a signal of a potential price decrease, the price only decreased by a very small margin. 

The price action is in a range. 

That’s why you should not always trade the MACD crossover. 

However, if the price action is in a strong trend, it will be good for you to trade the MACD crossover. 

If the trend is weak, don’t trade the MACD crossover. 

#2: Misinterpreting the MACD Histogram

Consider the chart given below…

mace-reversals-trading

The above chart shows the formation of a strong bullish momentum on a chart. 

Most traders will think that it’s time to buy, so they will go long. 

This is wrong. 

Why?

Because when such a move happens, it is already late and there are high chances that the market will reverse. 

The chart shows that a trend reversal in the bearish direction followed the strong bullish momentum. 

So, it will be good for you to go against the momentum, and trade the reversal. 

How to Use the MACD Histogram

Most trader like the idea of chasing breakouts. 

If the candles are more bullish, they end up buying the breakout. 

 However, the market makes a sudden reversal. 

Their accounts then get wiped out. 

This is the time such traders realize that…

They entered the trade when it is too late…

And they bought the currency pair when the price is about to reverse…

So, you need to ask yourself questions like…

“What if I stopped chasing breakouts?”

“What about taking the opposite side of the trade?”

“What if I went short when there was a strong bullish momentum?”

It will work better.

But, what is a strong momentum?

The MACD Histogram helps you explain this better. 

It works as follows…

-Wait until the price comes into a market structure like Support, Trendline, etc.

-The MACD Histogram displays a strong momentum in the form of a high peak/trough. 

-Wait for a price rejection before you can trade in the opposite direction. 

Consider the chart given below…

macd-strong-momentum

In the above chart, the price action begins by moving into the Support area. 

The price is showing a bearish trend. 

The support is the black line running horizontally. 

At this point, the MACD Histogram shows that there is a strong momentum downwards. 

This is shown by the red inverted bars. 

A price rejection occurred immediately, and the price begun to move in the opposite direction. 

This is the best time for you to enter the trade!

Make sure that you trade in the opposite direction of the previous trend!

Consider the following chart…

trading-with-reversals

In the above chart, there is a strong move by the price action towards the Resistance. 

The price is showing a bullish trend. 

The resistance is the black line running horizontally at the top of the chart. 

At this point, the MACD Histogram shows a strong momentum in the form of a high peak. 

The price is then rejected and begins to move in a bearish direction. 

So, the MACD Histogram can help you know when the price action is in a strong trend. 

MACD Histogram Squeeze

As a trader, it is good for you to know how to identify explosive breakouts just as they are about to occur. 

The explosive breakouts normally occur when the market is experiencing a low volatility. 

A low volatility means that the price doesn’t swing too high or too low. 

It’s almost showing a sideways movement. 

The range of the candles will get small and tight. 

However, if you’re a new trader, it won’t be easy for you to spot this. 

The MACD Histogram can help you spot this quickly. 

But how?

Here is the answer…

  • The price comes to a key market structure such as Support, trendline, etc. 
  • The MACD Histogram is almost flat with no visible peak/trough. 
  • Enter the breakout once the price breaks the market structure. 

Consider the following chart…

macd-indicator-and-volatility

The above chart shows the price lurking around the Resistance. 

The Resistance is the black line running horizontally on the chart

The area on the price action marked with a blue rectangle shows low volatility

At the same time, the MACD Histogram is showing a low volatility. 

This has been marked using a blue rectangle. 

The Histogram bars are flat at this point. 

Most of the Histogram bars are of the same size. 

The price then breaks through the Resistance line in a bullish direction. 

This is a great opportunity for you as a trader to enter the trade. 

After the breakout through the resistance line, a sharp increase in the price of the currency pair occurs. 

A trader who had bought the pair will make profit. 

Consider the following chart…

how-to-use-the-macd-to-measure-volatility

In the above chart, the price came to a market structure, which is Support. 

The Support is the black line running horizontally. 

When the price reaches the Support, it shows very low volatility. 

This is the region on the chart that has been enclosed in a blue rectangle. 

The region is characterized by small-bodied candles in a sideways movement. 

At the same time, the MACD Histogram looks almost flat. 

All the Histogram bars are almost of the same size. 

The price then breaks through the Support in a bearish direction. 

This is a good time for you to trade the breakout. 

Now that you have seen how the flat Histogram is formed, you might ask yourself this question…

“For how long should the MACD Histogram remain flat?”

There exist no fixed rules for this. 

But it will be good for you if you consider at least 5 candles. 

The higher the number of candles, the better. 

The reason is that if it remains flat for long, the resulting breakout will be stronger. 

Conclusion:

So, you’ve learned the following…

  • The MACD indicator is a momentum and Trend Following indicator. 
  • MACD is made up of two Exponential Moving Averages and a Histogram. 
  • The MACD Line moves faster than the Signal Line. 
  • The Histogram bars reflect the gap between the MACD Line and the Signal Line. 
  • The larger the gap, the larger the Histogram bars and vice versa. 
  • MACD is calculated using Moving Averages, hence, it is a lagging indicator. 
  • MACD helps traders discover new trends and identify the end of the current trends. 
  • Don’t trade the MACD Crossover blindly. It will be good if you trade it when the price action is showing a strong trend. 
  • If a MACD Crossover occurs during a weak trend, it is more likely to send a false signal.
  • Use the MACD Histogram to predict market reversals. Identify a strong move into a market structure such as Support followed by a price rejection. 
  • A flat MACD Histogram is an indication that the market is ready for a breakout. 
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