MACD is know as momentum indicator and used to identify market trends, MACD is usually charted with four components: MACD, a zero line, a signal line and a histogram. MACD is derived from the difference between two exponential moving averages.
Standard Settings: 12 for the fast moving average and 26 for the slow moving average. These moving averages are not shown on the chart but instead are used to plot the MACD line itself.
As an indicator, MACD fluctuates above and below a centre line or zero line. When MACD is above the zero line, the faster moving average is above the slower moving average, indicating that the market is moving up. If MACD is below the zero line, the faster moving average is below the slower moving average, suggesting that the market is moving down.
The next line of importance is the signal line. The signal line is actually an exponential moving average of MACD. The standard setting for the signal line is usually nine periods. Because the signal line will trail MACD, many traders use MACD and the signal line together, looking for crossovers to identify new trends. In trending markets, this works reasonably well, but in sideways markets, crossovers can be misleading.
The MACD histogram fluctuates above and below the zero line. It is positive when MACD is above the signal line and negative when MACD is below the signal line.
The size of the histogram represents the distance between the signal line and MACD, and can be interpreted as the strength of the trend. When the histogram is increasing in size, the trend is strengthening. When the histogram is decreasing, especially following larger bars, the trend is weakening.
IDENTIFY STRONG TRENDS
Although many traders look for MACD and signal line crossovers to enter new trends, numerous crossovers can appear in sideways markets, making this approach slightly aggressive and difficult to trade. Instead, traders should consider looking for a MACD/signal line crossover and then wait until MACD is above the zero line for an uptrend or below the zero line for a downtrend.
Simply put, traders should look for the following conditions to find strong trends using MACD:
• Uptrend: MACD is greater than the signal line and MACD is greater than the zero line
• Downtrend: MACD is less than the signal line and MACD is less than the zero line
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