Festive Learning: Using the MACD to Determine a Trend

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In previous posts within this series, we have covered, Bollinger Bands and moving averages, where we’ve shown how each technique can help determine the trending condition of an asset. If you haven’t already, please look back at our timeline to view these posts.

Now we want to look at another trending indicator, which can help to provide a quick and easy read of the current trend. This is called the Moving Average Convergence/Divergence indicator, or MACD for short.

The MACD uses 12 and 26 day exponential moving averages (EMAs), which are the default settings within the Pepperstone charting system.

Exponential averages differ from simple moving averages as they place greater emphasis on the latest closing data for a particular instrument. This goes someway to try and overcome the issue of averages being lagging in nature.

By giving the latest closing levels greater importance within the exponential calculation, these averages can turn more quickly than a simple average, to reflect price direction changes earlier.

What is the MACD and How Does it Use Moving Averages?

The MACD uses 12 and 26 day EMAs and measures the gap between the two.



This is important as the 12 day EMA will follow the price action of an instrument more closely than the 26 day EMA.

Meaning, as prices rise above the averages in an uptrend, the gap between the shorter and longer term EMA increases in a positive way.

While in a downtrend as price falls below the 2 declining averages, the gap increases in a negative way.

Let’s look further at the daily chart of AUDUSD and add the MACD indicator to see how this works in practice.



The blue line of the indicator shows the gap between the 2 exponential moving averages, while the red line is a 9 day moving average of the indicator line.

What Does the MACD Show, and How Can We Use This to Help Within Our Day to Day Trading?

It’s a trending indicator, so we use it to confirm the trending condition of an instrument, but we also use it to help us decide if whether our sentiment towards that instrument should be positive or negative.

There are 4 possible signals we can highlight by using the MACD.

These are,

• an aggressive uptrend,
• an aggressive downtrend,
• a correction within an uptrend
• a correction within a downtrend.

An Aggressive Uptrend Signal.

This is where the rising MACD indicator line (blue line on the MACD chart) is above zero and above its own average.



This reflects the 12 day EMA being above the 26 day EMA, and the gap between the two averages is increasing, as the price of an instrument moves higher.

This set-up reflects when sentiment should be positive towards an instrument, as the potential is that the current uptrend could continue.

Aggressive Downtrend Signal

The aggressive downtrend signal is when the MACD indicator line (blue line on the MACD chart) is falling below both zero and its own average.



This reflects where the declining 12 day EMA is falling below the declining 26 day EMA, as both averages track the declining price of an instrument.

This can highlight when sentiment should be negative towards an instrument because the current downtrend may extend further.

But what about consolidation signals?

Consolidation Within an Uptrend

A consolidation within an uptrend can develop when the MACD indicator line (blue line on the MACD chart) while still above zero has crossed below its own moving average (re line on the MACD chart).



This is not a negative signal because the MACD line is still above zero suggesting an uptrend is currently in place, but it highlights a reaction to the recent price strength is appearing and that a possible consolidation within the uptrend may materialise.

It can suggest a period where we may wish to close any long positions in the instrument at this point and revert to the sidelines, as a downside correction could be due.

We would then look for the MACD line (blue line on the MACD chart) to either break below zero to suggest a downtrend is now evident, or the more aggressive uptrend to resume if the MACD line breaks back above its own average.

Consolidation Within a Downtrend

A consolidation within a downtrend is seen when the MACD line (blue line on the MACD chart) is still below zero but has crossed above its own moving average (red line on MACD chart).



Here, we may want to close any potential short positions, as a potential upside recovery may be developing.

This is not a positive signal because the MACD line (blue line on the MACD chart) is still below zero highlighting a downtrend is still in play, but suggests a reaction to recent price weakness is materialising and that a recovery is possible within the on-going downtrend.

We would then look for the MACD line to either break above zero to suggest an uptrend for the instrument could be starting, or for prices to resume their downside moves and for the MACD line to break under its own average (red line on MACD chart) to highlight the more aggressive downtrend is still dominating.

We can use these signals to either initiate outright trades, or to help us gauge the trending set-up within any instrument at any given time.

The MACD indicator could then be combined with other techniques to help time trade entry within the direction of the confirmed trend, which we hope to cover in future posts.

So, in recent weeks we have looked at various techniques and indicators to help us gauge the trending condition of an asset at any given time.

Each can be used either on their own or in combination with the other and price patterns, but we’re sure you will find them very useful to incorporate within your own analysis and trading.


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