Breakdown and application of MACD
After identifying the direction of the market, we will consider market’s “momentum indicators”. In a market trend, the price will not move infinitely in a straight line, and there will be impulsive waves and retracement waves in every trends. Usually the first impulsive wave signals us to confirm the trend direction, so it is difficult for trend traders to trade the first impulsive wave. In an effective trending market, when the impulsive wave slows down and the price pulls back, bulls and bears will enter the market, pushing the price forward and forming the second impulsive wave. Momentum indicators can help us visualize the energy changes of bulls and bears.
Momentum indicators such as RSI, MACD, Stochastic, WPR, Momentum, CCI, or oscillator indicators are widely recognized by traders. If you are interested to deep further down and study the equation and logic behind momentum indicators. You can find various classical momentum indicators in the “Navigation”>”Indicators”>”Oscillators” column in Meta trader 5. In this dimension of momentum analysis, we will focus on the usage of MACD and Trend Scalp.
Breakdown and application of MACD
To put it plainly, MACD is a derivative of a double moving average system, or the visualization and recalculation of the double moving average system. A technical indicator that makes use of the aggregation and separation between the short-term moving average and the long-term moving average of the closing price to signal the timing of buying and selling.
There are two types of MACD, single moving average MACD and double moving average MACD. Because the moving average of the MACD window belongs to the re-calculation of the double moving average system, it does not make much sense to use this single and double moving average as a trading signal. The biggest contribution of MACD to traders is an expression of quantity and energy, or the speed of price movement. This is why we are willing to observe and analyze MACD.
We have set up two moving averages (Exponential Moving Average) in the chart window as 12 and 26 respectively. Comparing the MACD indicator in the following figure window, it can be clearly seen that when the double moving average system of the main chart crosses, the MACD bars will cross the zero axis (marked by a red line).
Therefore, the height of the MACD bars is actually the vertical distance between the 12 and 26 moving averages. When the distance of the double moving average is wider, the height of the MACD bars will be higher. This value is called “Difference Value” (DIF).
After understanding the nature of MACD, let’s talk about the general application of MACD.
- When the bars crosses the zero axis
– When the bar line crosses below the zero axis, indicating that the selling momentum is greater and the price may continue to fall.
– When the bar line crosses above the zero axis, indicating that the buying momentum is greater and the price may continue to rise.
- The bar line is gradually return to the zero axis, but failed to break below, and continues to lengthen.
– When the bar line above the zero-axis straight line gradually returns to the zero axis, and then increases again. It means that the retracement momentum of the upward trend has slowed down and the price may continue to rise.
– When the bar line below the zero-axis straight line gradually returns to the zero axis, and then increases again. It means that the retracement momentum of the downwards trend has slowed down and the price may continue to fall.
- MACD window patterns
We will explain the chart patterns in the subsidiary window after Trend Scalp. The patterns includes top-bottom convergence and divergence, double top-bottom, head and shoulder, etc.
Four major misunderstandings of MACD
- Does not understand the principle of MACD, deification of indicator
As soon as many traders get the MACD indicator, after seeing several profit opportunities, they feel that they have found the holy grail of trading. It is believed that MACD can play the role of catching tops and bottom in different timeframe. Or to conclude the rules of MACD convergence divergence or zero-axis crossing excessively. After reading the above explanation, we can know that MACD itself is only the visualization of moving averages. It is still necessary to analyze the momentum of bulls and bears, and use MACD as a subsidiary indicator for reference.
- Using MACD alone to trade
MACD is a subsidiary indicator. We must match MACD with other indicators that covers different dimension of the market. We cannot use MACD alone for trading.
- MACD Universal timeframe
We do not recommend to use the default parameters in every time frame when trading with MACD. We suggest traders to use the default parameters (fast EMA: 12, slow EMA: 26) on higher than 4-hour time frame. But if you want to trade in a smaller time frame (4 hours or less), you can use parameter as below,
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