MACD Indicator – Description and Application

MACD is among the most popular trading indicators. It is short for moving average convergence/divergence. Gerald Appel created and used it for technical analysis of stock prices in the late 1970s. It is designed to reveal changes in the strength, direction, momentum, and duration of a trend in a stock’s price. Since then many traders learnt to use it and include in the trading strategies.

The Pocket Option terminal offers MACD indicator in the standard set of tools for trading.

A successful professional money manager Gerald Appel introduced MACD in 1979. He also wrote more than fifteen books and many articles on investment strategies. He is a recognized expert in the field of technical market analysis. MACD turned out to be a great tool not only for Forex but also for binary options.

It is hard to overestimate the value of MA Convergence/Divergence tool because it  allows accurately determine the direction of the current trend and predict its reversals.

The appearance of the indicator

Like all indicators, MACD is displayed in a separate window under the chart. MACD is often displayed with histogram (see the screenshot below) which graphs the distance between the MACD and its signal line. If the MACD is above the signal line, the histogram will be above the MACD’s baseline. If the MACD is below its signal line, the histogram will be below the MACD’s baseline. Traders use the MACD’s histogram to identify when bullish or bearish momentum is high.

Settings for Convergence/Divergence MA

MACD triggers technical signals when it crosses above (to buy) or below (to sell) its signal line. It is calculated by subtracting the 26-period EMA from the 12-period EMA. The speed of crossovers is also taken as a signal of a market is overbought or oversold.

The experts recommend the following parameters:

• Period 12 for quick line;
• Period 26 for slow line;
• Period 9 for the histogram.

The Pocket Option terminal has the recommended settings as default settings.

However, if your strategy requires changing the MACD parameters, then you can change settings by clicking on “Indicators/Active” and then clicking on the pencil image. You also can change the color of the lines.

MACD Indicator Signals

Traders use MACD to find out the direction of the current trend and predict its reversal. The general interpretations are the following:

• If the histogram bars are below the zero level and are colored red, it means downward;
• If the histogram bars are above the zero level and are colored green, it means uptrend;
• When the bars are close to zero, it indicates a high probability trend reversal.

MACD measures the relationship between two EMAs and can generate signals to open a transaction:

• If a fast MA crosses a slow MA from top to bottom, it indicates a downtrend;
• If a slow MA crosses a fast MA from bottom to top, it indicates a uptrend.

How to Trade Options Trading Using MACD

The MACD indicates if the market is still increasing in buying or selling momentum. It may signal an upcoming trend change by showing divergence from price (price continues higher while the indicator turns lower, or vice versa). General recommendations are:

• Place a Call option when the histogram approaches the zero level and the fast line should crosses the slow line from the bottom up.

• Place a Put option when the histogram drops below the zero level and the fast line crosses the slow one from top to bottom.

Also MACD perfectly reflects divergence – a situation where market behavior diverges from the indicator. In this case open a contract in the direction indicated by the histogram.

MACD strategy can be used with any timeframe. 

The recommended expiration period equals the time of formation of two candles.

One of the main problems with divergence is that it can often signal a possible reversal but then no actual reversal actually happens – it produces a false positive. The other problem is that divergence doesn’t forecast all reversals. In other words, it predicts too many reversals that don’t occur and not enough real price reversals. Some traders wait for a confirmed cross above the signal line before entering a position to reduce the chances of being “faked out” and entering a position too early.

Short-term trading offers the best of both worlds. You can make short, fast, exciting trades and know your profit or loss before you trade. With Pocket Option, you can trade active markets 24 hours a day, 7 days a week. You can also use a free trading demo account to test your strategies and understanding of trading.