You may have noticed the MACD and RSI indicators available within your trading platform, but how exactly can you put them to good use? We break down these acronyms and their application for you here.
Understanding the MACD
The MACD is a trend-following momentum indicator, and its acronym stands for moving average convergence divergence. That might sound complicated, but essentially this indicator measures the strength of price movement using three moving averages. A 12-period exponential moving average is subtracted from a 26-period EMA and the larger the distance between the two, the greater the momentum is for that time.
A nine-period EMA is also plotted over the chart and this provides what’s called the signal line. When the MACD line crosses above or below the signal line this indicates a reversal of a trend; that is, suggesting that it can be ideal to buy when MACD line crosses above that signal line, and sell when MACD line crosses below the signal line.
Understanding the RSI
RSI stands for relative strength index and this indicator helps to show when a move may be exhausted and a trend is about to reverse. Where MACD measures the relationship between moving averages, RSI measures price change. The RSI is restricted to a 0-100 range and typically based on a 14-period moving average. When the moving average drops below 30 the price is considered to be oversold and when above 70 it’s considered to be overbought. The trick is to wait until that line jumps back within the 30-70 range to find your entry point.
Using the MACD and RSI together
The MACD and RSI can be used independently of one another, but used together they can help to avoid false triggers. This three-step process relies on the RSI to indicate and the MACD to confirm a change:
1.RSI puts you on alert of a price being overbought or undersold until it comes back to the 30 or 70 line;
2. MACD provides the trigger point to enter when the MACD line crosses the signal line; and
3.At this point you can look to the current price for your entry.
Once you get used to interpreting the MACD and RSI indicators, you can put stops and profit targets in place such as trailing stops and fixed amounts to minimise your risk. Finally, remember that indicators are just that – indicators. While they can’t guarantee any specific result, they are incredibly useful in suggesting what is likely to happen.
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