The MACD (Moving Average Convergence Divergence) indicator it’s a generator of buy and sell signals, used to predict the movement of the market, through the recognition of the trend of an asset.
The use of MACD is more effective when it occurs at the beginning or end of a trend or when is trending up/down. It can give wrong signals when the movement it’s lateral.
Initially it was designed to analyse stock market trends and is currently used for the analysis of many markets (forex, stocks, crypto). Despite the fact that there are hundreds of indicators, the MACD is one of those that have remained over time. The reason it’s that on higher timeframes it’s very effective.
How MACD works
The MACD indicator is generated by subtracting two exponential moving averages (EMAs) to create the main line (MACD line), which is then used to calculate another MPE representing the signal line.
In addition, there is the MACD histogram, which is calculated based on the differences between these two lines. The histogram, together with the other two lines, floats above and below a central line, which is also known as the zero line.
Therefore, the MACD indicator consists of three elements which move around the zero line:
The MACD line: helps to determine the upward or downward thrust (market trend). It is calculated by subtracting two exponential moving averages (EMA).
The signal line: is an EMA of the MACD line (usually 9 period EMA). The combined analysis of the signal line with the MACD line can be useful to detect possible reversals or input and output points.
Histogram: is a graphical representation of the divergence and convergence of the MACD line and the signal line. In other words, the histogram is the difference between the two lines.
How the MACD Indicator Works
In general, exponential moving averages are measured according to the closing prices of an asset, and the periods used to calculate the two EMA are generally defined by 12 periods (faster) and 26 periods (slower). The period can be configured in different ways: minutes, hours, days, weeks or months.
Assuming the default time intervals, the MACD line itself is calculated by subtracting the 26-day EMA (exponential moving average) from the 12-day EMA.
MACD line = 12d EMA – 26d EMA
As mentioned, the MACD line oscillates above and below the zero line, and this is what signals the so-called crossovers of the center line, showing traders when 12 and 26-day EMAs are changing their relative position.
How to use the MACD indicator:
Crossings at the moving average can allow to identify buy and sell signals in the following way:
Buy signal: Indicates a buy signal when the curve of the MACD line blue colour on the graph- crosses with the line of its moving average or signal line black colour on the graph, in an ascending way. The buy signal remains as long as the MACD line remains above its moving average. Ideally when the cross over happens bellow the histogram the buy signal has more power.
Sell signal: A sell signal occurs when the MACD line crosses its moving average downward and remains so as long as the MACD line is below its moving average. For a better sell signal that need to happen when the cross over happens above the histogram.
Like any indicator, it is highly probable that the MACD will generate false buy or sell signals, so it is essential to combine this indicator with other indicators or patterns.
For example for buy and sell signal in a trendy asset we like to use the MACD combined with the 200 EMA. When the asset it’s above the 200 EMA and there is a buy signal that could be a confirmation to buy or for instance sell when there is a sell signal.
We used MACD to trade $MRNA in combination to the 200EMA it gave us very good signals for a while. Remember always the higher the time frame the higher the probability to have better signals.
How to spot a divergence?
Divergence is understood as the discordance between the path indicated by the MACD and the path of the price. Through them, buy and sell signals can be obtained that show possible changes in the trend.
There are two types of divergences:
Negative divergence: It occurs when the price reaches its highest maximum while the MACD indicator indicates a lower high. The signal points to the strength of the price uptrend coming to an end and is a sell signal. On the histogram, a negative divergence is indicated by a price that keeps rising while the histogram goes down.
Positive divergence: It is the opposite situation, in which the price marks lower minimums while the MACD indicator indicates its highest maximum. The signal points to the change in the price trend towards the upside, being a buy signal. Positive divergence occurs when the histogram begins its upward trajectory while the price continues to decline.