MACD divergence is a popular method for predicting reversals, but unfortunately it isn't very accurate. The MACD line is faster than the signal line, and it will typically cross above and below the slower signal line. The same principle works in reverse as prices are falling. Even though it is possible to identify levels that are historically overbought or oversold, the MACD does not have any upper or lower limits to bind its movement. June 18, at 4:
What is the 'Moving Average Convergence Divergence - MACD'
As you see, the MACD line is faster and it often breaks the signal line. The gray bars are the histogram, which move in harmony with the distance between the two lines of the indicator. On most trading platforms, the MACD indicator typically comes with the default parameters 26, 12, and 9. We will interpret the meaning of these three numbers and how they apply to the structure of the indicator. These two numbers concern the calculation of the faster MACD line.
The structure of the MACD line comes with calculating a period Exponential Moving Average on the price action and then subtracting a period Exponential Moving Average from the result. The difference between the two EMAs gives you the value of the faster line.
Although the MACD indicator consists only of three components the two lines and the histogram it can provide a myriad of signals. We recognize six basic signals of the MACD and now we will discuss each of these separately. The MACD line is faster than the signal line, and it will typically cross above and below the slower signal line. Above you see a bullish MACD crossover. The green circle shows the moment when the faster MACD line crosses the signal line in the bullish direction.
The price action increases afterwards. When the general price action on the chart and the MACD direction are in contradiction, this clues us in that the price is likely to change directions.
In the green rectangle on the image above you see a case where the fast MACD line gains a relatively big distance from the red signal line. This indicates an oversold MACD signal.
The price of the Forex pair increases afterwards. As you see, the MACD indicator is pretty rich on technical signals, and is a very versatile trading tool. You can also trade effectively by using MACD in combination with price action analysis. The indicator is attached at the bottom of the price graph. The image starts with a bearish divergence between the price action and the MACD indicator. As you see, the price creates higher highs, while the tops of the MACD indicator are decreasing blue.
The two MACD lines cross afterwards and the price drops. Then we see four more price swings related with bullish and bearish MACD crossovers. Every time the two lines cross we see a price swing in the direction of the crossover. In this case, the price decreases after a bearish MACD crossover.
However, 7 periods later we see a potential oversold MACD signal. The MACD line gains a significant bearish distance from the signal line. This implies that the Forex pair may be oversold and ready for a bounce. As you see, the price increases afterwards.
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For example, a stock price that is rising and a MACD indicator that is falling could mean that the rally is about to end. Conversely, if a stock price is falling and the MACD is rising, it could mean that a bullish reversal could occur in the near-term.
Traders often use divergence in conjunction with other technical indicators to find opportunities. Dramatic Rise - When the MACD rises dramatically - that is, the shorter moving average pulls away from the longer-term moving average - it is a signal that the security is overbought and will soon return to normal levels. Traders will often combine this analysis with the Relative Strength Index RSI or other technical indicators to verify overbought or oversold conditions.
Traders also watch for a move above or below the zero line because this signals the position of the short-term average relative to the long-term average. When the MACD is above zero, the short-term average is above the long-term average, which signals upward momentum. The opposite is true when the MACD is below zero.
As you can see from the chart above, the zero line often acts as an area of support and resistance for the indicator.