Moving Average Convergence Divergence (MACD)

Moving Average Convergence Divergence (MACD)

Introduction to the MACD

The MACD, or Moving Average Convergence Divergence indicator, is a technical analysis indicator created by author and trader Gerald Appel in the late 1960s, that can help traders gain an edge in the market, and predict when critical short- and long-term trend changes are about to take place on the price charts of financial assets such as forex, stocks, crypto, and commodities.

 

MACD Definition

The MACD, pronounced and called the Mac-D, stands for Moving Average Convergence Divergence for short. The MACD demonstrates the relationship between 2 lines representing moving averages of a financial asset’s price. The MACD often includes a histogram to further assist traders with providing a visual representation of the strength of a trend and so any crossovers are clearly defined.

The MACD is used to discover new short-term trends and help identify when current trends are reaching a point of exhaustion, potentially signaling a trend reversal ahead.

 

Why The MACD Matters

Although the MACD is often referred to as a lagging indicator, it is among the most widely used technical analysis indicators in existence, and a cornerstone of any good trader’s toolset, regardless of if they are trading forex, crypto, or stock charts.

The MACD can effectively act as an indicator confirming trend changes with a bearish or bullish crossover of the signal line. However, the MACD often times can give false positive readings on trend changes that don’t actually occur, therefore it’s important to utilize the histogram and other technical indicators or price patterns to confirm signals on the MACD before taking a position.

 

How the MACD Works

When the short-term moving average – the EMA 12 – is above the longer-term moving average – the EMA 26 – then the reading is considered a positive value and a buy signal. When the long-term moving average is below the short-term moving average, it’s considered a negative value and a sell signal.

In additional to being used to watch for a cross of the signal line before taking a long or short position, the MACD is also used by traders and technical analysts to spot divergences, or rapid rises and falls in an asset’s price. These rapid rises or falls tend to signal that an asset is overbought or oversold, and can be used in conjunction with the Relative Strength Index for superior trading signals.

Oftentimes the MACD will set a lower low or higher high, while the asset’s price sets a higher low or lower high, creating a divergence in price. Divergences indicate that the underlying price action doesn’t represent what’s reflected on price charts, and usually precedes a powerful move.

 

How the MACD is Calculated

The MACD is calculated by taking the 26-period Exponential Moving Average and subtracting it from the 12-period EMA to create the MACD line. Then a nine-day EMA of the MACD called the signal line is plotted over the MACD line to complete the calculation and formula.

 

How to Read the MACD

The MACD’s value is positive whenever the 12EMA is above the 26EMA, and the value is negative whenever the 26EMA is above the 12EMA, meaning that when the lines cross, it often tells traders the trend momentum may be changing. If the two lines grow apart in distance it often signals that the trend is growing in strength.

The histogram takes the visualization a step further by showing the distance between the MACD line and the signal line as it grows.

 

How to Use the MACD

The MACD is used as a signal to buy or sell depending on if it crosses above or below the signal line. The signal line often begins to curl or turn ahead of major moves – spotting these early changes can be the key to a successful trading strategy. However, acting too early can be detrimental as the MACD can often show false positives.

The MACD histogram can also be used as a visual screener to confirm crossovers from bearish to bullish price action. The greater the distance between the signal lines, the larger the bars displayed on the histogram will become, and the stronger the trend. This histogram can also be used to signal reversals by watching for the histogram to round back toward and above the zero line.

The MACD is also a helpful tool when combined with other indicators and oscillators for confirmation along with chart patterns and other technical analysis. For example, the MACD is often combined with the Relative Strength Index, or Stochastic RSI.

 

The Best MACD Trading Strategy

There are a number of methods involving the MACD, however, the best strategy is often the most simple and straightforward one. For the MACD, trading bearish or bullish crossovers can often be the most effective.

Below you will find some examples on how to use the MACD effectively, and better understand how to read the helpful, trend-spotting technical analysis indicator.

 

Opening a Sell Order Based on a Bearish MACD Crossover

In the below BTC/USD price chart, the MACD can be seen beginning to make a bearish cross downward, signaling a sell on the asset’s price chart. If a trader opened a short position the moment, the bearish crossover happened, it would have resulted in a 50% drop, and using 100x leverage could have resulted in a 5,000% profit.

Moving Average Convergence Divergence (MACD)

Watching For Asset To Become Oversold

Once the MACD, following a bearish crossover, traders should watch for an asset to become oversold by waiting for the MACD moving averages to widen, signaling that the asset is becoming oversold. The wider the distance between the two MACD lines, the more oversold the asset is and a bounce could soon follow. Oversold conditions do not yet signal a buy.

Moving Average Convergence Divergence (MACD)

Spotting Early Buy Signal With Divergence

Oftentimes, traders can spot divergences in price charts that could signal a powerful move is ahead. In the below example, traders can watch for a large divergence between the MACD and an asset’s price chart. In this example, price sets a lower low, while the MACD diverges and sets a higher low, suggesting that buying is picking up steam despite price declining, and that a reversal may soon follow.

MACD indicator strategy

Opening a Buy Order Based on Bullish MACD Crossover

In the chart below, the MACD begins to tighten, eventually crossing upward into a powerful move. A buy order at this signal would have resulted in an over 300% return on investment at the peak.

Moving Average Convergence Divergence (MACD)

 

Preparing for Trend Reversal With Overbought Signals

The MACD can be utilized to understand when an asset is overbought. In the chart below, at each subsequent pullback, the MACD lines increasingly widen, showing that the asset is becoming more and more overbought, and possibly signaling that a reversal may be ahead. Eventually, the asset becomes so overbought, a trend reversal occurs and a downtrend follows.

Moving Average Convergence Divergence (MACD)

 

Scalp Trading Strategy Using the MACD

In addition to the above common strategies for trading using the MACD, traders can also make short-term scalp trades back and forth, with each minor bull and bearish crossover of the MACD lines.

In the below example, each time the MACD line makes a bearish crossover, it results in a sell signal and a short order should be opened. As the MACD line crosses back up bullish, it signals that a long order should be opened and a rally typically follows.

Moving Average Convergence Divergence (MACD)

 

Tips for Traders And Common Mistakes

The MACD can also be used to discover divergences between price action and the indicator’s signal lines, which can provide an early prediction that a trend change may soon occur.

However, divergences on the MACD are often considered an unreliable signal, due to false positives, so traders are urged to double confirm any divergences with other technical indicators in addition to the MACD.

The most common way for traders to utilize the MACD is with default settings over 12, 26, and 9 Exponential Moving averages, however, the settings may be tweaked for unique results. Other popular settings include a setting of 8. 17, and leaving the signal line at 9.

Beware of trading a bearish or bullish crossover too early, or search for confirmations in other indicators or chart patterns, as oftentimes the MACD will give a false positive signal.

Conclusion

Now that you have learned all there is to know about the MACD, also known as the Moving Average Convergence Divergence indicator, it’s time to try your chances at trading using the signal.

The MACD is just one of many technical indicators offered on the PrimeXBT trading platform. The trading platform provides all of the tools needed to develop a winning and profitable trading strategy, allowing even new traders to grow their capital quickly, safely, and easily.

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