Today we’re going to talk about the MACD indicator (pronounced mac-dee or M-A-C-D).
We’re going to go through what MACD is, and then we’re going to give you a tutorial on how to use it to trade. For many, especially newcomers to trading FOREX, the MACD indicator is a simple tool to start trading. It’s easy to read. The trade signals are not complicated. Simply put – used by itself, or with other indicators, it can be useful in your trading toolbox.
There are a few ways that traders use the MACD to trade, and we will cover the main ones here. To start though, let’s just talk about the MACD indicator is.
What is the MACD Divergence Indicator?
MACD stands for moving average convergence divergence. The indicator uses the difference between two EMAs (exponential moving averages) to plot market movement. Let’s take a closer look at the elements of MACD, and then we’ll look at how you can use it to trade.
- MACD Line – This is the main part of your MACD indicator, it is calculated using the difference between two EMAs. In this case it’s the difference between a 12 period EMA and a 26 period EMA.
- MACD Signal Line – The signal line is calculated using an EMA of the MACD line. In this case it uses a 9 period EMA of the MACD line.
- MACD Histogram – The histogram is calculated using the difference between the MACD line and the signal line. It is important to note that not all charting software uses the histogram.
- Center Line – The center line is used with certain styles of MACD trading, and is basically the zero line of the indicator.
- MACD 12,26,9 – The most common setup for the indicator is a 12 period ema subtracted from a 26 period ema. The 9 period ema uses those differences to create the signal line. If your trading style requires a different setup those numbers can be adjusted. In this tutorial we will be using the common 12, 26, 9 MACD indicator.
How Do You Trade the MACD?
With an idea of what the MACD indicator is, and what it shows, let’s dive in.
There are a few ways to trade with the MACD. We will cover the two most common ones here. Your style of trading will dictate which method is the best for you.
If you tend to day trade – that is, you tend to hold trades only for only a day or so – trading the first method with shorter term charts may be your best choice. If you’re a swing trader and you hold your trades for weeks or months at a time, the second method will be a better choice.
Day Trading the MACD – Signal Line Crossovers
Before we teach you how to trade signal line crossovers, let’s talk about when it’s best to do so. The MACD indicator is an excellent trading tool for shorter terms (minute charts, 5-minute charts, etc.) when the market is moving quickly. If you are in a slow-moving market, this trading style will give all kinds of false signals.
With that said, let’s dive right in. Here are our rules for trading:
- The signal line has crossed over the MACD.
- Both the MACD and the signal line have turned in the same direction (ie pointing down for a short position, pointing up for a long position).
- The Histogram agrees with your position (it will be below the centre line if going short, above the centre line if you are going long).
- We hold our trade until our signal lines cross again.
- Don’t reverse your trade again off the exit signal. Often the exit isn’t a complete reversal, and usually the currency will trend sideways for a bit. Be satisfied with the money you made on the trade itself.
Signal 1 – The signal line has crossed over the MACD line. The histogram is below the centre line. Both the MACD and the signal line are pointing down. This is our indication to go short on the GBP/USD. We will hold that trade until the lines crossover again and the trend reverses.
Exit signal – the lines cross again. End your trade.
Signal 2 – The market is still moving quickly. The signal line has crossed over the MACD line. Both lines are pointing upward, and the histogram is above the centre line. This is a clear buy signal. We go long and hold the trade until our next exit signal.
Exit signal – the lines cross again. End your trade. At this point, the market has gone flat and is trending sideways. This is clear to see by the MACD lines following the centre line instead of trending way above or way below.
Swing Trading the MACD – Center Line Crossovers
The MACD isn’t just for day traders. It can be an excellent (and very easy) indicator for Swing traders. Here is a very simple method to swing trade using the MACD. If you use a trailing stop-loss (with enough room to allow the currency to move) it can be a very profitable way to trade.
This is a very simple method to trade. There are three rules:
- Both the MACD and the Signal line have crossed the centre line.
- Both lines are trending the same direction (i.e. the signal line isn’t turning away).
- We exit when the lines cross the centre line again.
With this method of trading, you can reverse positions when you exit if the 3 rules are followed. I also highly recommend a trailing stop-loss to protect your profits. Let’s look at a chart for an example.
- Both lines have crossed the center from below – they are both trending in the same direction. Go long.
- Both lines have crossed from above to below. Exit trade 1 and go short.
- This is a false signal – if you are using a trailing stop-loss trade 2 would have exited a couple days prior (and protected your profits). This time the signal line is turning away from the MACD – don’t trade.
- Both lines have crossed the center line and are trending in the same direction. Go short. Depending on your stop-loss, the trade may have exited a few days later. But the charts don’t go far enough to show us the actual result.
Going Further with MACD
To finish, I want to say that these are not the only ways you can use this indicator. Some use MACD with other indicators to come up with their own trading strategy. Others use MACD with multiple time frames on different charts and only trade if the indicators agree. Whatever you decide, this indicator is an excellent tool to get you started in the world of FOREX.