Why the MACD indicator is so popular?
I have already made a video on the best MACD strategy, but in that video, I never talk
about why MACD is one of the most useful Indicator out there.
This video is not about the MACD strategy.
In this video, you will learn, how MACD can improve your existing trading strategy, by
giving you some really useful information.
Do you find yourself taking trades at the end of the trends?
Then this video is for you.
Lets say, when you open a chart of a stock or forex pair, you see this.
Bunch of big red candles in a row.
Is this a down trend?
If yes, where should you enter your position?
Should you enter now?
Well, if you enter now, how do you know the price is not going to reverse as soon as you
enter the trade?
How do you know if the strength of the trend is still strong or weak?
What If I told you, there is an easy way to identify the strength of the trend?
In the MACD video, I talk about how the crossover of the MACD lines can be used as an entry
signal generator.
In this video, lets talk about the histogram, and how it can be really useful to analyse
the chart better.
Before, we couldn't tell if the trend was weakening or not.
But If we add MACD to this chart, we can see that the MACD is indicating a weakness in
the down trend.
If you had entered a short position right here, you would have lost because the price
went up.
Furthermore, the MACD crossover also gave a long entry signal.
But how do these histogram bars show the strength of a trend?
Well, to answer that question, we will have to understand how the MACD indicator actually
works.
If you plot the MACD indicator on a chart, it will come with default input settings of
12, 26 and 9.
In simple words, what MACD really does is, compare the average of last 12 candles, with
the average of last 26 candles.
When it will compare these two averages, it will get a value that will indicate, whether
the average of last 12 candles is weak or strong when compared to the last 26 candles.
If that sounds confusing, Lets take a look at another example.
Lets say, there is a cat on a ladder.
On the first day, the cat climbs 10 steps.
On the second day, the cat climbs 40 more steps.
On the third day, 20 more steps.
On the Fourth day, 10 more.
And only 5 more step on the fifth day.
Now, anyone can tell that the cat is climbing upwards.
But if you look closely, you can tell that the cat is losing its strength day by day.
The cat is getting tired.
And finally decides to climb back down.
If you plot the strength of the cat using a histogram.
You will see it looks very similar to that of a stock or a Forex pair.
In our cat example, you can see how the strength of the cat is decreasing day by day.
MACD's histogram shows a similar thing.
On this chart, one would have said, that this is a strong downtrend.
But if we add the MACD indicator, we can see that, although it is a down trend, the strength
of the downtrend is getting weaker.
If it is getting weaker, there is a chance that the trend could reverse, or give a pullback.
And as you saw earlier, the trend did reverse, and started an uptrend.
Now remember what I said earlier.
This is not an entry signal strategy.
You cannot trade using the MACD histogram alone.
It is better to use it to analyse the strength of the trend, and you can also use it to improve
your existing Trading strategy.
Let me give you an example.
Lets say, you found a support area.
You are calmly waiting for the price to reach your support area.
But then few big red candles show up.
These red candles can indicate a possibility of a new down trend.
Instead of getting paranoid, you simply look at the histogram of the MACD indicator.
When the price comes near your support area, you see that strength of the downtrend is
getting weaker.
This is a good sign, as it can indicate a possible buying pressure at or near your support
levels.
Once you see the weakness in the downtrend, you simply wait for a proper long entry signal,
Like a candlestick pattern, and enter the trade.
In my support and resistance video, I showed a trade I took that made me 1000 percent profit.
That's 10 times what I had risked.
I took that trade near a resistance area.
And one of the reasons I knew that the resistance level was still working, was because, using
the histogram of the MACD, I saw the trend was getting weaker near the Resistance area.
If you ever find yourself unable to identify the strength of a trend, use the MACD indicator.
Also, In my previous MACD video, I said that MACD is a leading indicator.
Some people got confused.
How can an indicator be leading?
Well, most indicators calculate their values using past data, and show what is currently
happening on the chart.
On the other hand, MACD indicator not only relies on past data to calculate its data,
but it also predicts the possible change in the direction before other indicators.
Because it can predict a possible change in the direction, It is also known as a leading
indicator.
In fact, If you plot 26 and 12 period Exponential moving averages, and the MACD indicator on
the same chart, you will see that MACD gives an entry signal crossover way before the 26
and 12 period Exponential moving averages.
Well, now you know a little bit more about the MACD indicator.
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