Forex Technical Analysis: What Is An MACD Indicator?

The MACD indicator is one of the most useful tools of forex technical analysis but it is not usually well understood. This is a pity because many traders could probably use it more effectively if they understood it better.

The letters of its name stand for Moving Average Convergence Divergence. It is true that the name sounds rather complicated and unfortunately this is often enough to put people off from wanting to know more. So they only use the very simplest applications without understanding the power of the tool itself.

Like most forex tools, this indicator is used to show us when a new trend is forming, so that we can get in on it and make money. The MACD does this by plotting the relationship between two moving averages.

Settings

The settings are usually expressed as three numbers. Commonly you might see 12,26,9.

Traders using FX technical analysis often make the mistake of thinking that the first number on the MACD indicator (12 in this example) relates to the faster moving average line, the second number (26) relates to the slower moving average line and the third number (9) relates to the histogram at the bottom of the chart. That is not quite correct.

In fact the first two numbers (12 and 26) indicate the number of periods used to calculate two moving averages. The faster moving average line, which is often green on the chart, measures the moving average of the difference between the 12 period and the 26 period moving averages.

The slower moving average line is often red on the chart. This line plots the average of the last 9 (or whatever is the third number) periods of the faster moving average line. It usually shows smoother curves because its effect is to smooth out the fast moving average line.

Divergence And Convergence

The histogram that measures convergence and divergence is the series of blocks stretching above and below an axis near the bottom of the chart. This simply records the difference between the faster and slower moving averages.

As the two moving averages separate from each other (diverge), the blocks of the histogram will become longer. As they get closer (converge), the blocks become shorter. If the two lines cross, the blocks of the histogram will switch from stretching above the line to dropping below it or vice versa.

So the histogram measures the convergence and divergence of the two moving averages. And that is why this tool for FX technical analysis is called a Moving Average Convergence Divergence or MACD indicator.