Two of the most commonly used technical indicators of momentum in forex trading are the moving average convergence divergence, or MACD, and the relative strength index, or RSI. Both indicators are also popular with stock and futures traders.
The MACD appeals to traders and analysts, not only because of its reliability as a momentum and trend indicator, but also because its depiction in the form of a histogram offers an easy visual grasp of its measurement. The MACD is constructed with a short-term, or 12, and a longer-term, or 26, exponential moving average, or EMA. According to the theory behind the MACD, increased distance between the two moving averages, with the short-term average leading the long-term average by a wider margin, is indicative of increased market momentum.
The MACD indicator also plots a line that is a nine-day EMA of the value obtained by subtracting the 26 EMA from the 12 EMA. Finally, there is a zero line differentiating positive and negative values for the MACD, according to whether the short-term EMA is above or below the long-term EMA. Traders pay particular attention when price reaches a new high or low but the MACD does not, and this is commonly interpreted as signaling an impending change in market direction. One of the advantages of the MACD is that it often signals an upcoming trend change well before other indicators such as moving averages.
The RSI is primarily designed to indicate overbought and oversold conditions in a market by comparing recent price increases to recent price decreases. It is calculated on a 100-point scale. Generally, RSI readings over 70 indicate overbought conditions, while readings below 30 indicate oversold conditions, although some analysts look to more extreme levels of 80 and 20. In either event, traders often look for a possible retracement in price, interpreting the market as being overextended, at least temporarily, in one direction or the other.