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.
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.