While trading we have a plethora of tools or indicators to help us find optimal trades. One of the most powerful indicators is the moving average convergence/divergence indicator or MACD. This tool enables traders to identify trends and measure momentum of price action in the market. This makes decisions pertaining to entering trades and being bullish or bearish on the market much easier.
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The moving average convergence/divergence indicator is a tool which measures the relationships between 2 different moving averages of the price of a security in order to determine the direction of the trend and simultaneously the strength of the trend. The two moving averages considered are of 2 different timeframes ,i.e one short term and one long term usually ( 12 and 26 period respectively).
Firstly we have 2 Exponential Moving Averages: the 12 period EMA and the 26 period EMA. These two EMAs are subtracted which gives us the MACD line. This line can be positive if the 12 period EMA crosses over the 26 period EMA. Conversely it can be negative if the 12 period EMA is below the 26 period EMA line. A positive MACD line implies an uptrend while a negative MACD line implies a downtrend.
Secondly we also consider the 9 period EMA which is known as the signal line and it is plotted on top of the MACD line.
It should be noted that while the MACD is a powerful indicator it should not be blindly trusted. A seasoned trader uses a group of confluences before entering a trade. Thus the bullish or bearish bias discovered by using the MACD indicator should be combined with similarly bullish or bearish biases derived from other indicators , techniques or tools. This approach will yield the most profitable setups.
MACD is widely used due to its simplicity and ease of use. MACD acts as another way to identify trends and can identify when a trend might be losing momentum. It is important to note that the MACD indicator presents the current state of the market and does not guarantee that the state will continue further. For instance a strong bullish trend indicates that so far the market has appeared to be bullish but there is no guarantee that the trend will continue, thus it is important to combine the use of other tools and indicators before entering a trade.
In erratic markets or situations where a prominent bullish or bearish trend does not exist but rather a sideways trend the MACD indicator might suggest otherwise. This can mislead the trader who is too premature with their analysis. MACD is weakest in these situations and this drawback should be made aware of.
Axe Trader promotes indicators which have stood the test of time and proven themselves as reliable and consistent. The moving average convergence/divergence indicator is one of these powerful tools a trader should have in his/her arsenal in order to concur the financial markets. We encourage the use and combination of MACD with candlestick patterns , chart patterns and other tools to trade effectively and most importantly profitably.
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