MACD Indicator Explained

The MACD indicator is a popular trading tool that is used in many strategies. If you know how it works, you can build successful trades. In this short tutorial, we have gathered the most relevant information that will help you trade successfully using MACD.

MACD: Meaning

MACD is an abbreviation of Moving Average Convergence Divergence. Moving Averages are the key to MACD functions. The indicator is calculated as a subtraction of the long Exponential Moving Average from the short one.

This calculation helps build a core part of the MACD indicator – histogram. For instance, the histogram rises when the distance between moving averages increases. It’s a divergence. Convergence occurs when MAs get closer. As a result, the histogram becomes smaller. Besides the histogram, the MACD indicator includes two lines – MACD and signal.

MACD: Signals

MACD is a rare indicator that provides a lot of signals.

Zero Line Crossover

Zero line crossover is based on histogram movements. If the histogram crosses the 0 line bottom-up, there are odds of the upcoming uptrend. If the histogram goes below the 0 level, a downtrend is anticipated.

This signal is more reliable within a strong trend. A weak trend and significant volatility may lead to additional histogram fluctuations, which cause fake signals.

Crossover

A crossover signal includes movements of MACD and signal lines. A buy sign occurs when the MACD line crosses the signal line from bottom to top. You can sell when the MACD line goes below the signal line. Again, the signals are stronger within a sharp trend.

Convergence/Divergence

As the MACD name includes Convergence Divergence, you could expect such a signal. Convergence/divergence depicts a difference in the direction of the price and the indicator. If the price declines, setting lower lows, but the histogram’s lows are higher, it’s a bullish convergence. You can use this situation to buy. A bearish divergence is a situation when the price rises and the MACD falls – it’s a sign to sell.

Overbought/Oversold Areas

MACD, like other oscillators, can depict periods when the asset is overbought/oversold. Unlike the RSI tool, which has specific levels of overbought/oversold condition – 70 and 30, the MACD doesn’t have them.

You need to find the highs or lows of MACD and signal lines and compare them to previous extremums. If they exceed them, it’s a sign of an upcoming correction.

If the MACD is in the overbought area, the price may correct down soon. If the MACD is in the oversold area, expect an upward correction.

MACD: Use or Not to Use

Let’s highlight the advantages and disadvantages of the indicator. It will help you use MACD more efficiently.

Limitations

We want to start with disadvantages as there are not many of them.

  • MACD provides delayed signals. On the one side, its signals are more reliable. On the other side, the risk of fake signals on short timeframes is high.
  • MACD doesn’t determine ready-to-use Stop Loss and Take Profit levels.

Benefits

The MACD indicator has plenty of benefits, which can encourage you to use it in trading.

  • MACD is an irreplaceable trading tool as it’s a source of many signals. It’s unlikely you will implement the indicator and not get any alerts.
  • MACD can be implemented to any timeframe and asset. Still, we would like to warn you that it doesn’t work well on small timeframes as it’s a lagging indicator.
  • MACD is simple. If you keep this tutorial and practice several times, it will be easy to catch MACD signals.

MACD: Settings

The default settings of the MACD indicator are 12, 26, 9. They are the best for many trading strategies, but not for all. If you are experienced enough, you are recommended to try various parameters to find the one that will match your trading style.

If you are not experienced enough, you can apply 8, 17, 9 well-known settings. If you prefer intraday trading, you can use the 3, 10, 16 combination. 5, 35, 5 are mostly applied to shorter timeframes as they are more sensitive to price volatility.

Tips for Traders

A reason for unsuccessful trades isn’t only fake signals but traders’ mistakes.

The first one is a wrong reading of the histogram. Although some traders think the rise/fall of the histogram depicts the power of buyers/sellers and consider it as a signal to enter the market, the histogram only shows that bulls/bears prevail on the market. Moreover, it can be a sign of the upcoming correction.

MACD works well in a sharp trend and may provide fake signals within a weak one.

Overall, MACD is one of the most reliable trading indicators – it’s a source of various signals, can be applied to different timeframes, and works well for any asset, from currencies to CFDs. Thus, it should be among your trading tools.

Adam Hansen