Indicators are used to help traders read a chart. They are meant to assist you by giving you indications as to which way the market is going. You cannot base your trades on any one indicator. They are mere devices to assist you to decide whether to purchase a stock or currency but they are not to be followed blindly. And you must remember that they are not always correct. An important and popular indicator that is used a lot while charting the forex or stock markets is the moving average convergence divergence indicator or macd indicator.
What is macd? The use of indicators
This is a technical indicator useful for analytical study. It offers averages that move towards and away from each other, therefore the name is moving average convergence divergence indicator. The person who invented it was Gerard Appel in the late 1970s. Thomas Aspray added the divergence bar in 1986. It shows the interrelationship between two price averages that are moving. The macd indicator chart is composed of 2 exponential moving averages (EMAs) and a histogram. There are three numbers. These are employed as settings. The first is 12 that indicate the 12 bars to calculate the previous faster moving average. The second is 26 that shows the bars representing the previous slower moving average.
How it works
The macd can be looked at as an absolute price oscillator. (APO) It looks at actual prices of averages that move rather than at changes in percentages. As we have a pair of moving averages with speeds that are disparate on the chart, the faster speed will be quicker to react to the movement in price than the one that is slower. When there is a new trend, the faster line will show a reaction first and will, with time, go ahead of the slower line. When this happens and the faster line starts to move away from the slower line it may indicate a fresh direction in the market, either downwards, if it goes below or upwards if it goes above. At the point of crossing, the histogram temporally disappeared. This indicates that the difference is nil. When the faster line diverges from the slower one, the histogram gets bigger. This indicates a strong swing either up or down.
How to use it
The macd reveals subtle shifts in how strong the swing is and in what direction it is moving. When there are greater swings in the market, the macd helps a lot. Three useful ways to use macd are: when the lines cross; in overbought or oversold situations; and with disparities.
Besides the signal line crossover there is the zero line cross over. While the signal line crossover indicates that a movement in the stock or currency is about to gain momentum, the zero line crossover shows that there is a change in the trend, but not so much in its momentum. It shows that the average speed is changing direction.
The macd is also a good indicator of overbuying and overselling: The moving average that is shorter moves away noticeably from the moving average that is longer. This shows that the cost of the security is stretched and that it is likely to come back to a more reasonable amount.
A third way the macd helps is when there are disparities. It points out to the current trend being near its end when the macd moves away from the security. The macd may rise considerably but prices fail to rise along with it. This is an indication of an advancing market disparity. When it is the other way around i.e. when the macd arrives at new lows while the prices fail to do so, it shows a declining market disparity. These two disparities are crucial when they take place at levels that are overbought or oversold.
In such cases, it would be wise to apply a filter when the signal line is crossed by the MACD to ensure that it holds up. For example, if the macd goes above the signal line and remains there for three days, it would be a reason to buy. This could protect a person from a false signal, but it could also augment the possibilities of losing out on making a profit. There are many ways that are employed by traders to detect false signals and confirm true ones.
When macd crosses the signal line it shows that the direction of the acceleration is changing. When the macd crosses the zero line it shows average speed is moving in another direction.
ASK AND BID PRICES:
All FOREX trades operate on the principle of Ask and Bid prices. Ask Price is the amount that needs to be paid when one enters a buy trade i.e. when one buys a certain currency and the Bid price is the amount one needs to pay in a sell trade i.e. when one sells a certain currency. The difference between the Ask price and the Bid price is called Bid-Ask spread. This spread represents the trading charge and the broker’s commission.
When to use it
The Macd can be used as a daily, weekly or monthly chart. But it is good to be aware that it is only a trend indicator and needs to be employed with other indicators or studies to decide the point of entry that is more exact because the macd will only give you the direction of the movement and how strong it is. It won’t give exact points of entry or exit.
The macd has its disadvantages. As it is an indicator that lags, it gives signals after a movement has started and in a very volatile market it can give signals that are wrong. Then there are those who think that the macd price disparity is unreliable as it tends to be at a distance from its base. The way the macd is calculated is not easy and it can consume a lot of time.
