Of all the different kinds of forex technical studies that there are available there are three that seem to top the bill when it comes to being on more forex trading charts in the world than any others. Those three technical studies are the Moving Average Divergence Convergence indicator, aka “MACD”; the Bollinger Bands; the Relative Strength Index or RSI for short. These were equity trading tool but have successfully been brought over from equity trading charts on to forex charts with similar effect. If used on intraday timeframes, these indicators can lag price action so traders beware on that count.
Using these indicators on a daily chart or a weekly chart can assist traders in gauging validity of a signal given them on an intraday forex trading chart. Simplicity is best and that is what these indicators give. However, in days of instant gratification that we live in, a lot of traders do not want simplicity, but an instant holy grail that pays out dividends with no work. Not going to happen to the average Joe and will make the traders life very difficult.
Out of three indicators aforementioned, one of them is better for a channelling market and the others have been shown to work best when the market is in a trend. We’ll explore what makes each one work, how they work and why they work by exploring these questions in this series of 5 articles. We’ll also look at the optimum economic conditions under which these indicators work.
Let’s first of all look at the MACD or Moving Average Divergence Convergence indicator, originally put together by one Gerald Appel. It is known to be a reliable source of information for the forex trader when applied to the charts as well as being a simpler indicator to use and interpret. Recognising both trend and momentum of the price flow current, the MACD oscillator is a useful tool to the forex trader.
MACD consists of two lines – one is called the signal line and the other is the MACD line. These two are plotted together in an oscillator and a horizontal line centrally known as the zero line. The meaning of the zero line is that when the oscillator is above the zero line, the forex trader can ascertain that the exponential moving average for 12 periods is above the moving average for 26 periods. If below the zero line, the oscillator is saying that the 12 period EMA is now below the 26 period EMA.
Commonly, the MACD is interpreted by viewing the interaction of the MACD and the signal line. Simply, if the MACD line crosses above the signal line, a bullish signal is interpreted. Conversely, if the MACD line falls below the signal line, this is a bearish MACD signal. In addition, the power of a trend can be gauged by the relationship of the MACD line and the MACD signal line. As follows:
The wider the gap between the two lines (signal and MACD), the more strength the trend has. If the two lines are closer together, the trend is considered weaker. The degree of this separateness may be reflected on the indicator window by use of a histogram which will be above or below the zero line as stated earlier.
Lastly, a MACD can be used to look for divergence. This is found when a currency pair makes a new low, but the MACD fails to make a new low, further informing the trader that the trade is running out of steam – momentum is lower. This can be seen clearly by looking at a recent high/low in the price and then the latest high/low and seeing whether the MACD confirms strength in the trend by following suit, or does the opposite and makes a higher low/lower high in opposition to the price action.