MACD Chart: What is it?

The MACD chart is normally shown below the candlestick chart and provides useful forex trading indicators. MACD stands for Moving Average Convergence-Divergence. As the name suggests, it shows the convergence (coming together) or divergence (moving apart) of two exponential moving averages, one of which is fast and the other slow.

The indicator was invented by a New York stock analyst named Gerald Appel in the 1970s. Designed for the stock market, it nevertheless can be applied very well in other markets including forex.

On the MACD chart you will see two lines. One tracks the average of the difference between the two moving averages mentioned. Example settings for those might be 12 and 26 period moving averages. The other line on the chart is an exponential moving average of the MACD line itself, with a typical setting of 9. This is used as a signal line.

There are two simple ways to use the MACD. The first is to open a trade on the crossover of the two lines. If the faster line (the signal line) crosses the other from above, that can be treated as a signal to buy. If it crosses from below, that can be a signal to sell.

This can form the basis of a simple forex trading system which can be refined by checking the MACD in a second time frame. For example in day trading, look for the crossover on an hourly or 30 minute chart before moving in to the shorter time frame to make the trade. Then watch the higher time frame again for a signal that the trend is ending.

It is always best to consult the higher time frame first when trading on the basis of this indicator. This helps to prevent problems caused by trading against a longer term trend.

MACD can also be used to indicate overbought and oversold markets. When both lines are significantly above zero, the market can be said to be overbought. When they both fall significantly below zero, it is oversold.

The chart also includes a histogram giving a visual indication of convergence or divergence between the two lines. If the histogram is growing smaller, the lines are coming together. This can indicate that a crossover is approaching. The histogram is at zero when crossover occurs.

MACD is a lagging indicator and is prone to whipsaws when the market changes. Traders can be badly caught out. This is particularly true in the stock market where traders are relying less on the MACD these days. However, the MACD chart is still a useful provider of trading signals in many other markets, including forex.