Moving Average Convergence-Divergence (MACD)

MACD was originally constructed by Gerald Appel, an analyst in New York. Originally it was designed for analysis of the trend of stocks, but it's ease of use, it is in the study of many markets, such as FOREX.

MACD is constructed by making a moving average of the difference between two exponential moving averages, namely the Fast EMA and Slow EMA. This moving average and the MACD SMA can be plotted as two lines, one fast and one slow. MACD is normally defined as (12, 26, 9) where the Fast EMA is 12, Slow EMA is 26 and the MACD SMA is 9.

In the modern charting software, MACD is included as a standard package. Once selected, you can change the value of the Fast EMA, Slow EMA and even the MACD SMA. The MACD will plotted as two lines in the indicator window. These two lines are normally of two different colors.

1. MACD as a BUY/SELL signal
The simplest way to use the MACD is to locate the cross of two lines. If the faster signal line (the difference between the fast and alow EMA), crosses above the slower signal line (MACD SMA), a BUY signal is generated. The reverse to give a SELL signal.

2. MACD as an overbought/oversold indicator
The MACD can also be used as overbought or oversold indicator. As the level of both lines rises sbove the zero line, it starts to indicate the overbought state of the currency. The higher the two lines goes, the more the currency is into overbought condition.The reverse is true for the oversold conditiom.

The SELL signal will be very strong if the fast signal line cross down the slow line while both lines are in the overbought condition and the BUY signal will be very storng if the reverse occurs.

3. MACD as a divergence indicator
The last common use of MACD is that of divergence. If the MACD is making new lows and the price of the currency is not making new lows that is one form of divergence (bullish divergence).

Also, if the MACD has made a high and starts to heads down, but the currency is still making new highs, this is also a form of divergence (bearish divergence). The occurance of these divergence might lead to an indication of a possible reversal in direction.