Most traders are already familiar with the moving average convergence divergence (MACD) indicator, as well as how they can leverage this to become better traders. However, for beginners in trading, information about the MACD indicator can be considered as a piece of new knowledge. This article tackles the things that you need to know about the MACD indicator.
MACD Indicator in Brief
The MACD indicator simply shows the relationship between two moving averages of an asset’s price. To effectively calculate the value of this indicator, you need to find the difference between the 12-period and 26-period exponential moving average (EMA) of the asset’s price. The seasoned traders from NetPicks released an article on how you will be able to use the MACD indicator. It is in this guide where you will also find the best settings for intraday trading, as well as the best MACD indicator for MT4. Depending on your settings, you will be able to better understand whether the movement in the price is strengthening or otherwise. Some of the most common methods to interpret the MACD indicator is by crossovers, divergences, as well as rapid rises or falls.
The MACD is a lagging indicator because all of the data used to calculate it is based on the historical price movement of the asset. Nonetheless, some traders use the MACD indicator to predict when a change in the asset’s price will occur. In this case, it can also be considered as a leading indicator that can provide a good insight into future trend changes. Because of this, the MACD indicator can influence traders on when to enter, add to, or even exit a certain position.
When the MACD indicator falls below the signal line, it can be a good sign that it is time to sell. On the other hand, when the MACD indicator rises above the same signal line, then it is better to hold on to your asset because its price is most likely to go upward. However, it is better to wait for a confirmed cross above the signal line before you enter a position to avoid the risk of entering a position too early. Rest assured that when crossovers conform to a prevailing trend, they tend to be more reliable.
A divergence occurs when the MACD forms highs or lows the diverges from the respective highs and lows of an asset’s price. In this case, when the MACD forms two rising lows that also correspond to two falling lows on an asset’s price, then a bullish divergence is formed. Conversely, when the MACD forms a series of two falling highs that corresponds to two rising highs on an asset’s price, then a bearish divergence appears.
Rapid Rises or Falls
When the shorter-term moving average pulls away from the longer-term moving average, the MACD indicator can either rise or fall rapidly. This is an indication that an asset is overbought or oversold but it will soon return to its normal levels. However, to verify this condition, you should also use the relative strength index (RSI) analysis.
Common Mistakes with the MACD Indicator
●Trading the MACD Crossover
One of the most common mistakes that you need to avoid when it comes to the MACD indicator is trading the MACD crossover. While this technique may work in strong markets, it may prove to be ineffective most of the time as markets are continually in range. This means that the indicator can provide several false signals that can lead to a losing position. Thus, make sure to avoid the temptation of blindly trading the MACD crossover, rather, use it as a trend filter to increase your chances of earning a positive revenue with your investment.
●Misinterpreting the MACD Histogram
Most traders deem that during a strong momentum or a high peak in the move, it is time to buy. However, more often than not, after this momentum, the market is already more likely to reverse. This means that it is already too late to enter. In this case, a much better approach is to trade the reversal and stop chasing the breakouts. You just need to wait for the price rejection before trading in the opposite direction.
If you are keen on becoming a better trader, then familiarizing yourself with the MACD indicator will prove to be beneficial. As soon as you get ample information about this indicator, you will be able to use it to your advantage. Thus, it can help you earn decent revenue from your investment in the long run.