NoaFX Tutorial

5.2 The MACD Indicator

The Moving Average Convergence Divergence Indicator is one of the most popular indicators used by the trading market.

It is made up of a combination of moving averages and the various interpretations of these studies are visually represented in this indicator.

The MACD Indicator consists of;

  • 12 EMA
  • 26 EMA
  • Difference line representing difference between the 12 and 26 EMA
  • 9 EMA as the signal line
  • Histogram plotting the difference between the difference line and the 9 EMA
What does the MACD Compute?

Firstly, the MACD is only shown in the indicator window just below the actual price chart. There are no moving averages or indicators drawn on the actual price charts themselves. The illustration above bearing both the 12 and 26 EMAs is drawn to reflect how the difference line represents the actual "difference" between both the 12 and 26 EMAs drawn above.

Notice how that when the lines are furthest away from each other, the difference line is furthest away from the 0 or mid-point line. Notice that also when the market is ranging or sideways, the difference line is closely hugging the mid-point line, just as the 12 and 26 EMAs are intertwined with each other, bearing no difference.

Therefore, the difference line can be used to understand that;

  • A trend is prevalent when there is a difference between the 12 and 26 EMAs, causing the difference line to move away from the "0" line.
  • The stronger the trend, the further the difference line is from "0" line.
  • The difference line tends to be close to the "0" line when there is no trend and if the market is ranging.
  • A switch from the positive zone (above the "0" line) to the negative zone (below the "0" line), or vice versa, denotes a change in trends.
The Signal Line

Another component introduced in the MACD equation is the 9 EMA or otherwise known as signal line. The signal line, as its name states, provides the signal for a more responsive change in trend when it is intersected by the difference line.

The points of intersection between the signal and the difference line can be interpreted as trend changing signals.

Trading Off the MACD Signals

As we had discussed before, the responsiveness of the indicator is purely dependent on the latency between the actual behaviour change of the market and the indicator showing that such a change has happened.

Therefore, some traders will like to trade when the difference line intersects the "0" line whereas others feel that a more responsive signal as that provided by the intersection of the difference line and the signal line is more appropriate.

In summary, here are the various trading signals that have been generated by the MACD indicator;

Note: The signals generated by the difference line alone are fewer, but catches more good trend changes. The signals generated by the signal line are more and may consist of more false alerts, but catches the trends earlier.