What is the Moving Average Convergence Divergence indicator?
MACD is one of the most effective and relatively simple momentum indicators used to identify, follow and evaluate the strength and direction of a trend in technical analysis. It is one of the most popular tools that can be used to identify points of trend reversal for an asset as well as spot entry and exit conditions.
MACD on eToro
MACD is constructed by taking the difference between the ‘slow’ moving average indicator of 26-day period and a ‘fast’ moving average of a 12-day period; moving averages are constructed from the closing price of the asset and therefore actually depend on the price level of that security.
This indicator you see on eToro is made up of 2 lines that move on either side of the zero line: the MACD line and the ‘signal’ line, which is a 9-day period exponential moving average.
As you can see on the image above, you can always adjust the time periods of the moving averages to what best suits your trading strategy.
Trading using MACD
Signals of MACD come mostly from the divergence (when moving averages are drifting away from each other) or convergence (MA’s moving into the same direction towards each other) of the fast and the slow moving averages, just like the name suggests. Because the 12-day moving average smoothes prices over a shorter time period it reacts to changes in prices faster than the 26 exponential moving average.
The convergence or divergence of these two moving averages that make up the MACD indicator can then be interpreted as a signal that there is possibility of a trend developing and that you may consider entering a buy or a sell position. You can do so by observing the interaction of the MACD indicator and the zero line. MACD moves around the zero line and when it is positive (above the zero line), this indicates that the 12-day period moving average is above the 26-day one and there is a positive momentum in the upward direction is developing. This could be an opportunity for a buy trade. When the MACD line is negative (below the zero line) there is a downward momentum strengthening and this could be an opportunity for a sell position.
You can also interpret the interaction between the MACD and the signal line (which is the 9-day moving average); the signal line facilitates spotting turns in the MACD indicator. A bullish signal can be inferred when the MACD crosses the signal line from below and upwards and a bearish signal can be inferred from the indicator falling downwards through the signal line. You should beware however that when these crossovers happen at extreme positives and negatives; these could be caused be extreme volatilities and be over-predictive of momentum.
Also note that there is a histogram created for the MACD indicator which graphically charts the difference between the MACD line and the signal line. The histogram is positive for the periods when the MACD indicator line is moving above the signal line and negative when it is below.
Divergence of MACD
It is possible to infer a potential trend reversal from a condition referred to as the MACD divergence. It happens when the two indicator lines on MACD seem to be rising upwards while the price itself is falling and vice versa; for example, when the price of an asset reaches a lower low while the MACD reaches a higher high point, referred to as the bearish divergence. It can be quite risky to trade in these market conditions and should be approached with great caution.
As you hopefully saw from this article, MACD is a very useful indicator that combines together both trend and momentum indicator, helping to spot entry and exit points as well as possible points of trend reversals. Unlike for example, Bollinger Bands, this indicator is not bound by a range and cannot be used to identify overbought and oversold conditions of the market, but there are plenty of other indicators on eToro available to do so. Also, because the values of this indicator actually depend on the price levels of the underlying asset, it is meaningless to compare levels of MACD across different assets. Be careful with interpreting signals of technical indicators, especially in volatile market conditions. Remember that trading always involves risks of capital loss and should be done with caution. Best of luck trading!
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