MACD stands for Moving Average Convergence/Divergence and it is one of the widely used indicators in the world. The reason for that is the fact that it is extremely visible and easy to understand, making trading sound easy, which we all know it is not. However, there are a lot of traders that are using the MACD even combined with other indicators to create a powerful trading system and it is to be found under the oscillators tab on the Metatrader platform, but it is offered by any trading platform.
The Moving Average Convergence Divergence Indicator
The MACD is formed out of a fast and slow EMA (Exponential Moving Average) and one SMA (Simple Moving Average) and it is interpreted based on the zero level: sub-zero levels means a bearish market, so we should look to buy put options, while above zero represent bullish conditions and therefore we should look and but call options. The MACD SMA has the purpose of leading the market before turning bullish/bearish, but be aware of the fact that is often showing fake signals. MACD is an oscillator and like any oscillator it is showing overbought and oversold levels. However, it does have some special features in the sense that it can be used like a trend indicator as well and I will explain here what this means.
Using the MACD Indicator
When it is used like an oscillator, traders are looking for divergences between price and MACD in the same fashion like when trading divergences with the RSI (Relative Strength Index). You can find more about trading divergences with the RSI right here in our Binary Options Academy section. A divergence in a classical way means that price is moving in an opposite direction when compared with the oscillator and traders are always focusing on the oscillator rather than on price for the simple reason that the oscillator takes a bigger period into consideration.
The bigger the period the oscillator considers, the more powerful the divergence is and more valuable the strategy is as well. As a concrete example how to use this principle in trading binary options, one should look for price, in a bullish trend, to make two new highs, and in the same time the oscillator, in our case the MACD is failing to make the second high. This means the oscillator is diverging from price and it is being said that market is in a bearish divergence. A bearish stance means we should look to buy put options.
The opposite is true as well as if market is in a bearish trend and makes a series of two different and distinct lows but the MACD is not confirming the second low, it is said that market is forming a bullish divergence and call options should be traded. A divergence can be easily spotted by taking a simple trend line and connect the two highs or lows price is making. In the bullish case, the trend line will rise, in the second case, the trend line will fall.
Interpreting the MACD Indicator
On the oscillator part, it is exactly the opposite: the trend line will fall in the first case, and rise in the second. Like mentioned at the start of this article, MACD can be used as a trend indicator as well even though it is being plotted below the actual chart in a separate window. The way to do that is to stay on the short side or look to buy put option as long as the MACD lines are falling as this means the bearish trend is here to stay. The opposite is true as well and as long as the MACD candles are rising we should look to buy call options as it is implying the bullish trend is still intact and buyers will try to jump in every time market is dipping.
In plain English the MACD indicator means Moving Average Convergence/Divergence and I would say the name says everything about this oscillator. The expiration date to be used should be strongly correlated with the time frame the oscillator is being applied as this means it is pointless to trade end of month expiration date based on a five minutes chart. Another way to use for continuation trends when analyzing markets with the MACD is to set the zero level to be seen on the oscillator. By the time market is breaking the zero level from the downside to the upside, buy call options as a continuation pattern with the expiration date to be set according to the time frame the oscillator is plotted on.
The opposite is true as well put options should be traded on any more below zero market makes for the first time the zero level is broken. The video recordings that are coming with this article shows you where to find the MACD indicator, how to plot it on a chart and how to apply the three strategies discussed here.