The MACD uses moving averages which are lagging indicators but they are turned into a momentum indicator by subtracting the longer moving average from the shorter term moving average. This results in a line which oscillates above and below zero, with no upward or downward limits.
The calculation of the MACD is based on the difference between the two averages which are smoothed exponentially (EMA)
MACD = MA(P, nlong) - MA(P, nshort),
MACD Signal = MA(MACD, n),
where MA(P, nlong) - moving average of the price P within nlong periods
( the normal setting here is 26 days)
MA(P, nshort) - moving average of the price P within nshort periods
(the normal setting here is 12 days)
MA(MACD, n) - moving average MACD within n periods
(the normal setting here is 9 days)
In conclusion, the Moving Average Convergence/Divergence (MACD) is calculated by taking away the value of a 26-day exponential moving average from the value of a 12-day exponential moving average.
Using the MACD
The MACD is typically used to spot overbought and oversold situations, and for entering trading signals and is considered particularly effective in volatile markets.
The MACD Histogram represents the difference between MACD and it's signal line normally the 9-day Exponential Moving Average (EMA) of the MACD. If the MACD line is above the signal line, the histogram I will be positive, and the bars are above the zero line. If the MACD line is below the signal line, the histogram will be negative, and the bars are below the zero line.
Sharp increases in the MACD histogram show that MACD is rising faster than its 9-day EMA and upward momentum is strengthening. Sharp declines in the MACD histogram show that MACD is falling faster than its moving average and downward pressure in on the rise. Divergences between MACD and MACD histogram are the main tool used to anticipate crossovers. A positive divergence in the MACD-Histogram indicates that MACD is strengthening and could be on the verge of a bullish moving average crossover. A negative divergence in the MACD Histogram shows that MACD is weakening and can act to as a warning of a bearish move.
The main way a signal is generated by the MACD-Histogram is a divergence from MACD followed by a zero-line crossover. A bullish trading signal is generated when a positive divergence occurs and there is a zero line crossover to the upside. Conversely, a bearish trading signal is generated when there is a negative divergence and a cross to the downside on the zero line
In Technical Analysis of the Financial Markets, well known author John Murphy states the best way to use the MACD is by looking for when the spread between the two lines is widening or narrowing. When the histogram is above its zero line (positive) but starts to lose momentum or fall its time to take a contrary trade or tighten up stops and the reverse set up applies in a bear market.
The MACD is a useful indicator and can be used in both short and long term trading strategies but will generate a lot of false signals, like any indicator used in isolation but if you combine it with other complimentary indicators in your currency trading strategy, it's an essential indicator, for better market timing and more accurate trading signals and that means, bigger currency profits so make the MACD part of your essential currency trading indicators and you will be well rewarded for your efforts.