One of the most popular indicators within the context of foreign exchange rates trading is the MACD (or Moving Average Convergence Divergence). This indicator is pretty neat at spotting moving averages that might be changing to form a different trend. Given that MACD is in business to spot trends, it’s little surprise that a wide range of foreign exchange rates traders use it – trends are what give them their biggest paydays.
How To Trade Foreign Exchange Rates With The MACD
Whenever you plot the MACD, you’ll see that it comes with 3 numbers (for example 12, 24, 9). In this example, the 12 indicates the number of periods for the fast moving average, the 24 is the number of periods for the slow moving average and the third relates to the number of bars between the two.
The MACD indicator also displays a histogram – this histogram just indicates the difference that exists between the fast and slow moving average. So, as the pair of moving averages that we use in our MACD become wider apart, the histogram will get taller. When the histogram does get taller, it tells us that the moving averages are diverging from one another. In contrast, during periods where the moving averages get closer to one another, the histogram will become shorter – something that is known as convergence.
MACD is a trending indicator – we therefore use it to pick apart the strength and direction of trend. Since there are two moving averages – one fast, one slow, a new trend can be spotted with the MACD when the fast moving average crosses the slow one. In an uptrend, the fast will cut up and above the slow, and the reverse is true in a downtrend. As the trend gathers energy, the fast moving average will rip away from the slow moving average, indicating that the trend is getting stronger. This can be seen on the MACD indicator by the histogram bars getting progressively taller. This is when the MACD is in divergence mode – when the histogram bars are getting incrementally taller, and the two moving averages have an increasingly wide gap between them.
Of course, the key thing to remember with foreign exchange rates is that all trends must eventually come screeching to a halt. Ultimately, as the bullish or bearish momentum behind a prevailing trend slows down – the entire structure of the MACD indicator will change. A dissipating trend will be characterized by the fast moving average pulling back towards the slow, as the most recent price movement will be one of exhaustion. When this happens, the histogram bars will get incrementally shorter, reflecting the gradual convergence of the two moving averages. Finally, the trend may actually reverse if the slow moving average bites into the large moving average in the opposite direction. At this point, the height of the histogram will be negligible.
The actual time to trade the MACD is when the crossover happens, since this is what indicates a new trend formation. One thing to be wary of when trading with the MACD is that the indicator is prone to whipsaws. So, one crossover which might prompt you to go long may be immediately followed by another crossover that will prompt you to go short. Consequently, you should always use MACD as part of a well balanced foreign exchange rates trading plan, as opposed to in isolation.
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