Moving Average Convergence & Divergence Indicator (MACD)

The weakness of the moving average method is related to the calculation of buy/sell opportunities by working on past data. The slow prediction of buy/sell chances that are available is attributed to the problem of time lag that occurs as faster average (short-term average) takes longer to cross the slower average (long-term average) than the time taken by the actual price to cross one moving average.

The time lag is directly proportional to the number of periods. So, a 10-period moving average will predict a pair’s price slower than a five-period moving average. On the other hand, if a lesser number of periods is considered for reducing the time period of prediction, the resulting sensitive data will result in several money-losing signals (whipsaw). A short-term average will produce more inaccurate buy/sell signals, reducing the overall effectiveness of the method for technical analysis.

In order to improve the accuracy of the moving averages method and confirm its buy/sell predictions, it should be used in conjunction with other indicator(s), such as:
Moving Average Convergence & Divergence Indicator (MACD)
Non-Trend Following Indicators or Oscillators

Moving Average Convergence & Divergence Indicator (MACD): It was developed by Gerald Appel in 1979 to predict the forex market movement by employing the MACD line (the difference between two exponential moving averages and the signal or trigger line) oscillating between the zero line and the signals generated by the zero line crossover and the signal line (MACD line’s exponent moving average).

Uses of MACD
• Crossovers of MACD lines above/below Zero Line Crossovers: activates a buy signal when the MACD line crosses above the zero line and elicits a sell signal when the MACD line crosses below the zero line.
• Crossovers of MACD lines above/below of Signal Lines: activates a buy signal when the MACD line crosses above the signal line. The sell signal comes into action when the MACD line crosses below the signal line. The point at which the MACD line crosses above or below the signal line determines the strength of a trend.
• Divergence Signals: A divergence signal is a warning that prices are unlikely to sustain their current level and is generated when the MACD line does not follow the price trend. A bearish divergence signal is a warning that the upward price movement could be near its ceiling value and a bullish divergence signal is a caution that the downward price trend could be close to its floor value.

To know about the Non-Trend Following Indicators or Oscillators click here.

More On Forex.