There are 3 essential parameters that make MACD chart work:
- number of periods that shows faster moving average.
- number of periods that shows slower moving average.
- number of bars that shows the relationship (or a difference, in other words) between the faster and slower moving averages.
How is MACD calculated? Here is the formula:
12-day Exponential Moving Average (EMA) MINUS 26-day EMA
Also, you need a 9-day EMA which is called a "Signal Line". 9-day EMA is "drawn" on top of MACD chart and shows forex trader when to buy or sell.
There are 3 methods to be used with MACD:
- Whenever MACD is below the signal, it indicates that it is time to sell.
- Whenever MACD is above the signal, it indicates that it is time to buy.
- MACD crossings occur when the fast line crosses the slow line. When this happens and the fast line starts to drift away from the slow line, this is often considered an indicator of a new trend.
The disadvantage of MACD indicator is there is a bit of lag. This happens because moving averages are simply the averages of historical prices and therefore there is a lag behind price. Despite the disadvantage, MACD is still considered the most favorite indicator among forex traders.