Using the Moving Average Convergence Divergence (MACD)

 

What it is MACD ?

MACD means Moving Average Convergence Divergence. It is a momentum indicator which shows the relationship between two different moving averages

1. The 12 period exponential moving average – it is the Fast Length.

1. The 26 periods exponential moving average – it is the Slow Length.

The MACD line is calculated by subtracting the 26-period EMA from the 12-period EMA.
The signal line is a 9 period exponential moving average.

Then these two lines are drawn on top of each other. These are the two lines you see when you turn on the MACD indicator.

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Also, there is a histogram that shows the distance between two lines. Larger bars tell us that the MACD and the signal are further apart.

When it comes to candles, size matters. The larger the candlestick, the greater the momentum of the trend.

The histogram turns green when the MACD line is above 0 (bullish) and turns red when the MACD line falls below 0 (bearish).

Above is very bearish momentum. Photo taken on May 23, 2021.

How to use MACD ?

The most important thing to know about MACD is how to read the relationship between two lines.

I have found that the best time frame to use the MACD is daily. This is because the MACD is a lagging indicator and using daily data prevents many (not all) false buy and sell signals.

These are the signs:

• When the MACD line crosses the signal line, it is a buy signal.

• When the MACD line crosses the signal line, it is a sell signal.

Also, it is best to use MACD in trending markets; a market with a distinct bullish or bearish trend.

Using MACD with trend lines is a very powerful combination.

The reason for this is that if the market moves sideways, you may see small fluctuations at the intersections of the MACD and the signal line, but the price is not really moving anywhere. These are fake outbursts.

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Therefore, these signals are not automatic buying and selling.

There are ways to confirm the reading on the MACD chart.

One is a strategy that uses ways to use RSI and MACD together (which is beyond the scope of this text, but I will cover the scope of this my next article).

Another way is to use the MACD with the current trend. So, if you are in an uptrend, then you see a bullish cross, then this is confirmation that you are likely to go higher.

The same is true in the opposite direction

Also note that the transition occurs well after the price has stabilized or increased. Again, this is because 

MACD is a lagging indicator.

Leading indicator?

Since the MACD and signal lines are lagging indicators, is there anything that can be used for prediction?

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Some traders use the histogram to predict when a reversal will occur.

Since the MACD is a momentum indicator, it can show us when the selling pressure is easing. So now is a good time to buy.

This, of course, does not always work, but with good risk management (loss prevention), you can often enter a position long before a breakout.

Conversely, it can show you when your on long position and it is running out and alert you when to exit.

MACD Divergent

There is an other useful method to use the MACD is to find divergences.

A bullish divergence, it look like the RSI, is when the short-term price trend goes down and the MACD rises.

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Bearish divergence, also very close to the RSI, is when the price trend goes up and the MACD goes down.

MACD Divergent

Trading this way is sometimes not a good idea because you are trading against the trend. Practice good risk management if you trade reversals.

Also watch for the buy signal just before the circled sell signal. I really want to emphasize that the signals are not automatic buy and sell.

Price action is a great way to confirm a reversal (up or down) in a trend. Because simply spotting a divergence does not guarantee that the price will follow.

Final thoughts

As you can see, there are different ways to use MACD successfully. I hope that in this beginner's guide you have clarified some of these methods.

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