One of the most commonly used indicators is the Moving Average Convergence and Divergence (MACD). The MACD is one of the oldest and most used oscillators.
In MACD, a currency is oversold if a low value is indicated and, at that point, the currency is likely to reverse and start an uptrend. On the other hand, a currency is overbought when a consistent high value is indicated and, in this scenario, the currency will likely start a downtrend soon.
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The MACD chart uses 3 exponential moving averages (EMA). The most commonly used combination of values for these 3 averages is (12, 26, 9). These three values create a 2-part indicator. The top part is the currency’s 12 day and a 26 day EMA. The 12 day is the faster EMA and the 26 day is the slower EMA.
These 2 EMAs can be used to determine momentum of a currency. In our setup, when the 12-day EMA is above the 26-day EMA the currency is considered to be in an uptrend. The opposite is true for a downtrend with the 26-day EMA being above the 12-day EMA. When 12-Day EMA goes faster than the 26-Day EMA, the uptrend becomes more pronounced and gets stronger. Once the 12-day EMA slows down and the 26-day EMA closes the gap between the two, that usually indicates that the uptrend is coming to an end.
The 9-day EMA is known as the histogram. The histogram shows the difference between the fast and the slow EMAs. In a chart, as the faster and slower EMA separate, the histogram gets bigger. This separation is called divergence because one of the EMAs is moving away or diverging from the the other.
The MACD is a great indicator used by many traders to help determine trends and changes in trend. However, MACD should never be used alone and should always be used in combination with additional indicators such as stochastic to help you confirm the start and end of trends as they develop.
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