A:

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.

RELATED FAQS
  1. What are the main differences between Moving Average Convergence Divergence (MACD) ...

    Learn the differences between the moving average convergence divergence (MACD) and the relative strength index (RSI), and ... Read Answer >>
  2. Why is divergence of the Moving Average Convergence Divergence (MACD) important for ...

    Learn the importance of the moving average convergence divergence, or MACD, and understand why traders consider it an important ... Read Answer >>
  3. What are the main differences between Moving Average Convergence Divergence (MACD) ...

    Understand the exponential moving average, or EMA, and the moving average convergence divergence, or MACD, and their respective ... Read Answer >>
  4. What are the best technical indicators to complement the Moving Average Convergence ...

    Learn the best technical indicators to use as part of a trading strategy in conjunction with the moving average convergence ... Read Answer >>
  5. What do the bracketed numbers following a technical indicator mean?

    In technical analysis, it is common to see a series of numbers following a given technical indicator, usually in brackets. ... Read Answer >>
  6. How reliable is using the Moving Average Convergence Divergence (MACD) to create ...

    Find out why the moving average convergence divergence (MACD) oscillator is considered one of the simplest, most versatile ... Read Answer >>
Related Articles
  1. Trading

    Measuring Stock Market Sentiment With Extreme Indicators

    Pay attention to how the exhaustion principle helps technical indicators signal trend reversals when abrupt value changes coincide with high trading volume.
  2. Trading

    MACD And Stochastic: A Double-Cross Strategy

    Two indicators are usually better than one. Find out how this pairing can enhance your trading.
  3. Trading

    MACD Histogram Helps Determine Trend Changes

    Learn how this momentum indicator is used to determine price action on a stock.
  4. Financial Advisor

    Moving Average Convergence Divergence - MACD

    Learn about this momentum indicator that shows the relationship between two moving averages.
  5. Trading

    The Four Most Common Indicators in Trend Trading

    Here are the top indicators and tools trend traders use to establish when trends exist and find entry/exit points.
  6. Trading

    Why MACD Divergence Is an Unreliable Signal

    MACD divergence is a popular method for predicting reversals, but unfortunately it isn't very accurate. Learn the weaknesses of indicator divergence.
  7. Trading

    Overbought Or Oversold? Use The Relative Strength Index To Find Out

    The Relative Strength Index comes in handy when identifying areas that are potentially overbought or oversold.
RELATED TERMS
  1. Trigger Line

    A moving-average line found in the moving average convergence ...
  2. True Strength Index - TSI

    A technical momentum indicator that helps traders determine overbought ...
  3. Derivative Oscillator

    The Derivative Oscillator is a technical indicator that applies ...
  4. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator ...
  5. Indicator

    Indicators are statistics used to measure current conditions ...
  6. Dynamic Momentum Index

    An indicator used in technical analysis that determines overbought ...
Hot Definitions
  1. IRR Rule

    A measure for evaluating whether to proceed with a project or investment. The IRR rule states that if the internal rate of ...
  2. Short Covering

    Short covering is buying back borrowed securities in order to close an open short position.
  3. Covariance

    A measure of the degree to which returns on two risky assets move in tandem. A positive covariance means that asset returns ...
  4. Liquid Asset

    An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally ...
  5. Nostro Account

    A bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts ...
  6. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
Trading Center