...When a currency pair is volatile, all elements of the MACD show broad movements on both sides of the median line.
However, when the market is calm, moving averages converge and the MACD lines consolidate as well.These feature make the MACD indicator useful to measure volatility and market sentiment. Notice how each volatility boost starts after a period of consolidation.
The MACD indicator is an open indicator which means that overbought and oversold conditions are relative to previous highs and lows of the MACD line.
Being an open indicator implies that, unlike other oscillators with values ranging from 0% to 100%, in the MACD there is no maximum or minimum value. Since the EMAs forming MACD can't theoretically distance from each other ad infinitum, there is logically always a return of the lines towards the median line. To identify periods of overbought and oversold conditions, we must look at past figures in the range of values which the MACD has registered.
Technical indicators work particularly well when combined with each other. Besides, they also perform well with different settings than the default ones. A proof of it is the below illustration.
A 200 SMA has been displayed on the chart, combined with a MACD using the following settings: 21, 55, 8. You may ask again where these weird numbers are coming from. The answer is they belong to the Fibonacci sequence. The next section will cover the sequence in more detail, but for now just observe how an ascending 200 SMA acted as a filter for the signals generated by the MACD crossovers. The purpose was to go with the trend, therefore no bearish cross was taken as valid.Do you conceive the MACD or even moving average crossovers as the only way to determine the overall trend in your analysis? It's true these are great methods, but they always produce series of losses, specially when the market is consolidating.
There is another method which enables traders to profit from consolidation periods, and this is done by identifying divergences between price and the MACD lines.
One of the things traders look for are signs of convergence and divergence between price action and the indicator. A convergence is when the indicator and the price action are hinting a similar signal and, therefore, reinforcing their signals. But when the indicator and the price are telling a different story, there is a divergence, showing that price is not supported by the indicator.
There are basically four types of divergences, which can be identified with the MACD or any other oscillator (Stochastic, Momentum, RSI, etc.). Divergences, like its name suggests, happen when the price and the oscillator go in opposite directions, hence diverging from each other.
