Another day, another indicator. This time, we want to look at the MACD indicator to see what it is all about and how it might come in handy as you are trading. If you feel that your trading is lacking some indicators and tools that might be of use to you, then you need to listen to what is being spoken about here. There is a lot of value to be had in these indicators, and you don’t want to hobble yourself by not having them in your arsenal.

What is the MACD Indicator?

The MACD in the name stands for “Moving Average Convergence Divergence”. It is a mouthful to say all of that, so most people just shorten it to MACD. The purpose of this indicator is similar to the purpose of many others, and that is to help you find a trend out there.

After all, the majority of the money that a trader ever makes in the market comes from their ability to spot and identify a new trend. If they can manage to pull this off consistently, then they are in great shape to do well in the markets.

How Does the MACD Indicator Break Down?

The various elements of the MACD indicator are important to know about because you don’t want to take for granted that you know the mechanics of something that you are still learning a little about. Thus, you should be aware that the MACD indicator is made up like this:

1. Faster moving average — the MACD line: This is the first set of numbers that goes into it
2. Slower moving average — the Signal Line: The second set of numbers that are used to compare against the faster set
3. The difference between the two: Your final set of numbers seek to measure the faster-moving average against the slower moving one

The reason to have all three sets of numbers working at the same time is to try to show how they all compare against one another. What we know from many other indicators, and what the MACD indicator is so great at illustrating is that when the faster-moving averages cross over the slower-moving averages, that is usually the sign of something big to come.

The Parameters of the MACD

The parameters for the MACD are generally set at a standard default setting that is useful for the purposes of getting helpful information out of the indicator. The periods at set at: 12, 26, and 9.

In this case, the 12 is the moving average of the last 12 bars on the chart, the 26 is the moving average of the last 26 bars on the chart, and the 9 is meant to represent the difference between those first two numbers. When there is a big difference between the two numbers, the market is likely trending in a particular direction. When the difference between the two starts to close, the market may be ready to shift directions itself. This could be a big signal of things to come, and it is important to pay attention when this happens.

It is very nice that the MACD gives the difference between the two indicators in such an easy-to-understand method. This means that you can take a quick peek at the MACD indicator to get some idea of where the market may be headed, at least in the short term. You don’t want to rely simply on the eyeball test for determining exactly what is happening, but it is a good place to start if you are uncertain about what else you can do to figure out how to react to different price movements.

How to Trade the MACD Indicator

Since there are two moving averages with distinct speeds, the quicker one will understandably react faster to price movement than the slower one. When a new trend arises, the faster line — the MACD Line — will respond first and ultimately cross over the slower line — the Signal Line.

When this crossover happens, and the fast line starts to “diverge” or swerve away from the slower line, it implies that a new trend may have formed.

 

 

In the above chart, the fast line crossed UNDER the slow line and accurately detected a new downtrend. Note that when the lines crossed, the Histogram briefly vanishes since the difference between the lines at the time of the cross is zero.

With the start of a new downtrend, the fast line deviates away from the slow line, the histogram gets larger, which is a nice signal of a strong trend.

Keep in mind the disadvantage to MACD: Indeed, moving averages tend to LAG behind price. Thus, the MACD is a lagging indicator. After all, it’s just an average of historical prices.

Bear in mind the MACD indicator consists of three components:

1. The MACD Line — the difference between the two moving averages.
2. The Signal Line — a moving average of the MACD Line.
3. The Histogram — a graphical representation of the gap between the MACD Line and Signal Line.

Do not fret if the MACD indicator takes a little while to figure out. It is a bit more complex than some of the other offerings out there, but that is because it is such a powerful tool used by so many great traders. You might find yourself wanting to use it more and more as you discover all of the power that is behind it. Just be sure that you also combine other indicators into your trading so that you can get the fullest picture of what is going on in the markets whenever the desire to trade hits you.