Moving Averages
This rising and falling creates peaks and troughs in the MACD, and allows the
trader or analyst to look for standard or reverse divergences between the peaks
and troughs in price and MACD. The stronger the trend, the greater will be the
divergence between the two EMAs. As the uptrend or downtrend slows down, the
two EMAs begin to converge, indicating weakness in the uptrend or downtrend.
This is why the MACD is called the Moving Average Convergence-Divergence
indicator. The difference between the EMAs is zero when they meet, which causes
the MACD to revert back to its zero or equilibrium level. We see this clearly at
time lines 1 to 6. A smoothed version of the MACD represents its signal line.
Many practitioners prefer to use the MACD-signal line crossover as buy and
sell signals instead of the zero- or equilibrium-level crossovers. This is because the
MACD-signal line crossover provides earlier buy and sell signals. Whichever the
case may be, price confirmation is always required, by way of a price penetration
of some barrier overlay like trendlines, moving averages, support and resistance,
and so on. For more on the MACD, please refer to Gerald Appel’s book Technical
Analysis: Power Tools for Active Traders.
Notice the double detrending in Figure 11.22. If we detrend the MACD against
its own signal line and plot the differences, we get the MACD Histogram. This
oscillator tends to signal price reversal much more rapidly than the MACD, since
double detrending reduces the lag components between price and the oscillators.
As per the two EMAs, whenever the MACD and its signal line meet, the histogram
will be at its zero or equilibrium level, as seen at points A to D.
Figure 11.23 displays the result of detrending a 26-day EMA with price itself.
Such an indicator is called a price oscillator, which is essentially identical to the
MACD, except for the periods used. This is very useful as it isolates the historically
overbought and oversold levels in the market with respect to the behavior of price
to the 26-period EMA. In the Figure 11.23 below, we observe price making topsfigure 11.23 Detrending Price with a Moving Average on the Hourly Chart of
AUDUSD.
Source: MetaTrader 4