Oscillation

The MACD indicator acts as an oscillator. It moves up and down around a centerline at zero. The centerline is the neutral measurement and the oscillation up and down by the MACD lines represent if the currency is overextended (similar to RSI).

• Overbought conditions occur above the centerline, but are more prominent when they are far above. (Black arrows in Figure 5)
• Oversold conditions occur way below the centerline. (Red arrows in Figure 5)

In the VT software readings for the upper and bottom levels change depending on the currency pair (unlike RSI because calculations are more complex). A trader needs to examine past data to see what the appropriate levels are.

A trader using past upper and lower boundaries would sell the currency pair when it is overbought and buy the currency when it is heavily oversold. Buy signals come in mid January and mid June, while sell signals occur at the start end of 2004 and in August.

In mid-March, there are two arrows which would indicate a sell because the MACD indicator touched the upper boundary. The reversal in price that the indicator predicts (March 1st) is short lived and comes back up again. The currency enters a trading range. As mentioned before, trading ranges create problems for indicators that use exponential moving averages. Nevertheless, sometime in there, a trader using this strategy should get a short Euro position and wait for a buy signal that comes in June.

Using MACD’s oscillations as signals, it seems from this example that a trader could make impressive gains in a long term strategy over the seven months presented. The problem is that such easy signals will not always present themselves as they do so perfectly in this particular example. This is also a daily chart and signals present themselves over long periods of time. There may be long periods when the upper or lower levels are not touched. Also past levels of what is oversold or overbought may become unreliable as the market conditions change. However the principles presented can be used for all time periods.

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