Technical analysis focuses on charts to understand trends and identify the best points to buy or sell. It doesn’t take any macroeconomic, social or geopolitical factors into account, as these are included in fundamental analysis . An experienced trader will use both to plan their trade. In a previous lesson, we discussed ranging markets and the Relative Strength Index , which helps you identify overbought or oversold instruments. In this lesson, we will cover another indicator. Specifically, we will discuss Moving Averages and the MACD.
Moving averages are simple line charts that track how the average price changes over a specified period of time and they’re useful because they show you the trend in the simplest way possible while removing all the noise from short-term fluctuations. There are many different types of averages but most traders use these two:
First of all, choose the right moving average and period based on your trading style. We’d encourage you to stick with the most popular options (SMA and EMA) because these are used by most traders and markets are about momentum . If you look at the same thing that other traders see, you will move in the same direction so you will be riding the trend.
The MACD (Moving Average Convergence Divergence) is an indicator which you can take into account, alongside the RSI. It tracks the relationship between two moving average prices and it’s calculated by subtracting the 26-day EMA from the 12-period EMA. Once you have the MACD line, you also plot the signal line, which is the 9-day EMA of the MACD. The relationship between these two lines, triggers trader activity:
As with all indicators, their main limitation is they assume the price will continue to move in the same pattern. Before proceeding with a trade, you may want to confirm your prediction with different indicators, e.g. MACD and RSI. Also, you should be aware of the limitations of technical analysis and you should keep an eye out for figures and reports that could take the market in a completely different direction.