There are many technical indicators that can be used when trading Forex. This post will teach the basics of using the Moving Average Convergence Divergence (MACD) to analysis and trade Forex. To see a full-list of our technical indicator posts, please visit our Forex 101: Technical Indicator Basics page.
What is the MACD indicator?
The MACD is a technical indicator that is used to identify new trends and whether they are bullish or bearish trends. The MACD indicator looks like this...
The indicator consists of 2 moving averages and a histogram. Somthing important to note is that the moving averages are not based on price. Instead, they are based on the difference between 2 moving averages. If you need to learn about how to use moving averages, please read our Forex 101: Moving Averages post. The histogram simply plots the difference between the 2 moving averages plotted on the MACD indicator - as the moving averages get wider, the histogram gets bigger and as the moving averages tighten, the histogram gets smaller. The histogram also shows whether the moving averages are bullish or bearish. This is shown by the histogram plotting lines above the centre point or below the centre point.
How to use the MACD indicator
Knowing how a technical indicator is formed is not a necessity, what is more important is knowing how a technical indicator can be used to trade Forex.
Moving Average Cross
The most common way to use the MACD indicator is to simply use the moving average cross. When the moving averages cross bullish, this can signal that price may start a bullish trend. When the moving averages cross bearish, this can signal that price could start a bearish trend. Let's have a look at an example...
You should notice that each time the MACD crosses, price moves in the direction of the cross. Combining the MACD cross with price action and other technical indicators can be an effective way to analyse and trade the Forex market.
The meaning of divergence is difference. When price is trending and creating higher swing highs (in an uptrend) or lower swing lows (in a downtrend), the histogram can also be forming higher or lower swings. Look at the example below...
Do you notice that price is forming lower lows and is down-trending? Can you see that the histogram is also creating a lower lows?
Let's take a look to see what happens next...
The histogram forms a higher low and price moves higher - the downtrend is over. This is the basics of trading MACD divergence.
Some Forex traders use the MACD indicator as a way to signal when a position should be closed. Closing a trade when the MACD crosses against the position or the histogram starts to move against the position are a couple of common techniques for doing this.
Technical indicators should not be used as a way to signal when to buy or sell. Instead, technical indicators should be used as part of analysis. Please use a clear trading strategy and not solely rely on a single indicator for trading.