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1 Oscillators: the MACD on 30th September 2013, 12:45 am


The MACD may be interpreted similarly to other moving averages and used as a trend-following indicator. That is, when the MACD crosses above the MACD signal line, it's a bullish signal, and conversely, when the MACD crosses below the MACD signal line, a downtrend may be beginning and the signal is bearish.
Its default settings are usually 26, 12, 9 and these are its components:
1. The MACD line takes a short length and a long length exponential moving average (defaulted to 12 and 26) and calculates the difference between these two averages. (Note: the images herewith displayed use a custom MACD to evidence its lines, whereas the MACD is by default plotted as a column and line combination.)
2. A signal line is an exponential moving average of the MACD line. This is plotted as the MACD signal.
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3. The third element is the median line also called "zero line" or "center line".
The MACD moves around a center line and it has not upper or lower limits as other oscillators have (the RSI, for instance). It is thus called an "open oscillator". The median line represents the point at which the moving averages are equal.
If the EMAs which compose the MACD cross a bearish signal, the indicator translates it into a simultaneous bearish crossing of the MACD line with its median line. And vice versa, when the MACD line crosses its median line to the upside, this means the two EMAs built in the indicator are crossing upwards.
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4. Finally, the difference between the MACD and the MACD signal line is calculated and plotted in a histogram.
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If you are going to use the MACD, consider including the histogram as well. On occasion, the MACD itself may be following the price nicely, but the histogram can alert the trained analyst that a turn in price is in the air by giving signs of divergence. What a divergence is will be explained further below.
The same dilemma as for the moving averages applies for the MACD: shorter moving averages will be more sensitive and generate more crosses, and longer moving averages will always lag price and generate fewer signals.
Why then not change its default settings and do something creative with the MACD? The signals provided with the settings 36,81,18 may be few, but are they therefore less reliable? Note how the below settings evidence the start of a trend when the MACD line crossover is close to its median line. You may ask where this weird numbers are coming from. The answer is that they are multiples of 9.
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The MACD is based on the concept of convergence-divergence. But what is the convergence-divergence of a moving average? We have said the MACD consists of two exponential moving averages that range around the median line. The result is an indicator that oscillates above and below that line.
When the MACD is above the median line, this means the 12-period moving average is above the 26-period moving average, indicating that recent prices are higher than the previous ones.
Conversely, when the MACD is below the median line, it means the 12-period moving average has a value of less than 26 periods, indicating that prices are falling.
In other words, the bigger the spread between the two EMAs taken into the equation of the MACD line is, the more distance the indicator will print to its median line.
When a currency pair is volatile, the MACD shows broad movements on both sides of the median line. However, when the market is calm, its moving averages converge and the MACD line takes a break close to the median line.
This feature makes the MACD indicator useful to measure the speed and volatility. Notice how each volatility boost starts after a period of consolidation.
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The MACD indicator is an open indicator which means that overbought and oversold conditions are relative to previous highs and lows of the MACD line.
Being an open indicator implies that, unlike other oscillators with values ranging from 0% to 100%, in the MACD there is no maximum or minimum value. Since the EMAs forming MACD can't theoretically distance from each other ad infinitum, there is logically always a return of the lines towards the median line. To identify periods of overbought and oversold conditions, we must look at past figures in the range of values which the MACD has registered.
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Technical indicators work particularly well when combined with each other. Besides, they also perform well with different settings than the default ones. A proof of it is the below illustration.
A 200 SMA has been displayed on the chart, combined with a MACD using the following settings: 21, 55, 8. If you are wondering where these weird numbers are coming from, the answer is: they belong to the Fibonacci sequence. The next section will cover the sequence in more detail, but for now just observe how the ascending angle of the 200 SMA acted as a confirmation for the signals generated by the MACD crossovers. The purpose was to go with the trend, therefore no MACD bearish cross was taken as valid.
Do you conceive the MACD or even moving average crossovers as the only way to determine the overall trend in your analysis? It's true these are great methods, but they always produce series of losses, specially when the market is reversing.
There is a method which enables traders to profit from reversal movements, and it consists inĀ  identifying divergences between price and the MACD lines.

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