The trend reversal point is the stumbling block of any trader. Dozens, if not hundreds, of various indicators and candlestick patterns have been created to attempt to precisely determine it, because opening or closing a position as close as possible to the trend reversal point is the key to maximum profitability. The weakening of pressure from the bulls or the bears is most effectively shown by the MACD (Moving Average Convergence and Divergence) indicator.
From this article you will learn:
- How to trade with MACD indicator
- How to interpret MACD indicator
- How to use MACD indicator in day trading
- What are MACD settings.
What is MACD and how it is interpreted on MACD charts
The MACD indicator appeared on exchanges in the 70s and served to identify the direction of the trend and momentum, or the intensity of the price movement along the trend. This technical indicator has two varieties:
- the MACD line indicator: trend (lagging) indicator;
- the MACD histogram: an improved version of the line indicator, designed to be ahead of the signals given by the MACD line. It can be called an oscillator and used to make trading decisions.
On most modern exchanges, these two indicators are combined on one chart:
The value of the MACD indicator (blue line) represents the difference in values between the fast-moving (period 12) and the slow-moving average (period 26). This difference indicates the intensity of the trends. When the moving averages intersect, the MACD becomes zero. If the MACD is above the zero line, the trend is considered to be upward, and if it’s below, then it is downward.
The second line on the MACD graph (the red one) is the exponential moving average of the MACD line itself, with a step of 9. It is also called the signal line. It provides an earlier signal to trend reversal compared to the zero level of the MACD line. MACD histograms are constructed based on the interaction of the MACD with the signal line, but we should not use the histograms to analyze stock prices, since they are derived from the linear MACD.
In pursuit of discrepancies: MACD divergence and convergence
The discrepancies between the MACD indicator and the price on the chart are called divergence and convergence, depending on whether the trend is bullish or bearish. They act as a powerful and reliable MACD signal for opening or closing a position.
The most accurate are the divergences and convergences of class A. As a rule, they are followed by a steep reversal. Divergence A is formed when the rate updates the price maximum but the next indicator’s maximum is lower than the previous one. The reverse situation indicates a convergence of A, or a change in trend from bearish to bullish. This constitutes a signal to open a long position.
Divergence B indicates a weakening of the bull trend and its immediate correction. This signal is less reliable, since the price may have a reserve for further movement in the same direction.
In markets with high volatility, one can often observe class C divergence and convergence. This discrepancy suggests that there is only a slight drop in momentum, and such signals should not be given significant attention.
As a rule, both vertices are analyzed to detect discrepancies. But in some cases, the price confirms its trend at the next extreme, and the indicator shows the opposite. Such a situation is considered to be an even more reliable signal for opening or closing a position.
It is also possible to track discrepancies directly inside the MACD index, as they are an indicator of the intensity of the development of a trend. Thus, the divergence of moving averages occurs when the distance between the moving averages increases and the price increases rapidly. Then, the trend develops with greater speed. In this case, the MACD line is moving away from zero. The convergence of the moving averages, on the contrary, occurs when the moving averages approach each other. The impulse then subsides, and the trend slows down. The MACD line is thus nearing zero.
Signals based on MACD in the Xena Exchange terminal
Divergence is considered one of the most powerful signals, and high-grade trading strategies are built on its basis. In the Xena Exchange terminal, the signals to buy or sell an asset based on the MACD index are reflected directly on the MACD divergence chart for the convenience of the trader.
Nevertheless, before drawing conclusions based on divergence or convergence, it’s necessary to make sure that there’s a clear trend developing on the market, since a large number of false signals may appear during flat periods. The more obvious the difference traced on the market, the greater the number of traders who will react to it, which increases the likelihood of a correct forecast. The probability of error always exists, and we recommend that you limit risks by using stop orders.