The Moving Average Convergence Divergence (MACD) is one of the most effective technical analysis indicators. It is a trend following indicator that many traders follow religiously.
The MACD Trading strategy was developed by an individual called Gerald Appel in the 1970s and is an effective oscillator that gives the trader an idea of trends in the underlying asset.
It is important to note that although the MACD indicator is an oscillator, it is not bound between particular ranges. This is why it is not particularly useful for identifying overbought or oversold levels.
In the below post we will go through a few some of the most important MACD trading strategies that the trader can use in order increase their profitability.
What is the MACD
MACD Line: (12 Period EMA – 26 Period EMA)
Signal Line: 9 Period EMA of MACD Line
Histogram: MACD Line – Signal Line
The MACD is an indicator that is calculated by taking the difference between a short term Exponential Moving Average (EMA) and a long term EMA. The difference between the two is the MACD line.
There is another line that is also drawn and this is the MACD signal line. This is nothing more than an exponential moving average of the MACD line itself.
Many MACD charts also include a histogram which is calculated as the difference between the MACD indicator and the signal line. These can be either positive or negative depending on the positions.
The most common inputs chosen for the MACD indicator are the 12 and 26 EMA lines. The signal line is a 9 day moving average of the MACD line.
Interpretation of the MACD
As mentioned, the MACD is an indicator that is able to give an indication of how strong an asset’s trend is. As you can tell, the MACD is all about spotting periods when the two moving averages are either converging or diverging. These are strong indicators of whether a trend is picking up steam or petering out.
When the MACD indicator is above the 0 line, this means that the short term EMA is above the long term EMA. If this is also increasing then it is a signal that the upside momentum is increasing and is indeed a bullish sign.
On the other hand, when the MACD is below the 0 line it means that the short term moving averages are below the long term moving averages. If the MACD keeps on falling this means that downside momentum is also increasing.
The signal line is also a helpful addition to the tool kit of the trader. This is because it is able to help the trader spot if there are going to be any divergences or convergences in the MACD indicator itself.
Taking a look at the below example, we have the price of EURCHF. The 26 and 12 moving averages are plotted on the main chart. Below that we have the MACD indicator where the MACD line is in light blue and the MACD signal line is in red.
As one can tell, the MACD is the difference between the two moving average lines. In this case, it is quite clear that the price is indeed trending upwards and momentum is picking up. This is because the MACD is above the 0 line and increasing.
Top 3 MACD Trading Strategies
We will take a look at 3 of the most important MACD technical trading strategies. These are based on particular formations and indications from the chart itself.
We are plotting the charts below with candlestick indicators and with a range of different time periods. It is important to note that the MACD, line most technical studies, can be viewed over really any time frame.
MACD 0 Line Crossover
This is one of the most common MACD indicators and occurs when the MACD line crosses over the 0 line of the MACD chart. This is sometimes also termed a “centreline” crossover.
A centre line crossover is an indication that the asset may be changing the direction of the momentum. For example, if the MACD indicator goes from positive to negative it is an indication that momentum has gone from upside to downside.
In the case of a crossover from the top, this is a bearish centre line crossover. On the other side, if the MACD goes from negative to positive then this is termed a bullish centre line crossover.
Generally, a bullish crossover is a sign that the trader should by the asset and a bearish crossover is a sign that the trader should sell the asset.
However, there are periods in which the MACD line will remain around the 0 line for a considerable period of time without showing any sign of positive or negative momentum. When these “weak” MACD trends present themselves, the trader should operate with caution.
Taking a look at an example, in the below chart we have the price of Ether in USD plotted with 5 minute candles over a 4 hour period.
As one can see in the chart, there was a period prior to the crossover when the MACD line was relatively flat and meandering around the 0 line. This showed that there was no momentum in the charts above.
However, there was a sudden jump in the MACD as the line went from negative to positive and crossed the centre line. This was a bullish crossover and was a strong indication that the momentum had indeed switched to positive and started to pick up in a upward direction.
Signal Line Crossover
Another really helpful crossover that technical traders watch keenly is the signal line crossover. This happens when the MACD indicator itself crosses over its moving average (Signal Line).
This is something that is borrowed from the reading of traditional bearish / bullish signals when an asset price crosses over or under its moving average lines.
When the MACD line crosses over the signal line from the top then this is considered a bearish crossover. On the other hand, when the MACD line crosses over from the bottom it is considered a bullish crossover.
Taking a look at an example, in the below chart we have the price of Spot Gold plotted over the span of 2 hours with a 2 minute candlestick chart.
As you can see, the MACD line was trending downwards for the first few minutes. This was an indication that downside momentum was increasing. However, this reversed course and the MACD crossed over the signal line from the bottom. This was a bullish crossover and was an indication that the downside momentum was changing course.
Indeed, shortly after the bullish signal line crossover, the MACD line itself crossed over the 0 line which reinforced the bullish signal and was an indication that upside momentum was picking up considerably.
The trader would then have entered a long position on spot gold on the crossover. The position could have been held for a few more minutes where the trader could have closed it out when it looked as if the MACD line was turning and heading downwards.
In fact, there was a bearish signal crossover a few minutes later which was a sign that the trader should indeed short the price of gold after he / she had exited the long position.
Given that the signal line is a moving average of the MACD, the trader should be careful of crossovers that occur at extremes extreme highs or lows as these can be misleading.
When an asset price is diverging from any oscillator, this is usually a sign that something is about to change. This is particularly acute when it comes to a MACD divergence.
This is because a divergence in the MACD from the price means that momentum is moving contrary to the way that the asset is moving. These are always more cautionary indications that the trader should avoid entering positions with the trend.
There are two types of divergences that the trader should look out for. These are a bullish divergence and a bearish divergence.
A bullish divergence occurs when an asset price is reaching lower lows but the MACD line is reaching a higher low. This is an indication that the price trend may indeed reverse as momentum appears to be preceding price.
A bearish divergence occurs when the price is reaching a higher high but the MACD line is reaching lower highs. This is an indication that although the price itself may be increasing, momentum was tapering off and was losing steam.
In the below chart we have the S&P 500 index that is presented on a chart with 10 minute candlesticks.
As you can see, the price of the index was increasing over the middle of the day. However, the MACD itself was decreasing and making lower highs. This was a clear sign that momentum was starting to fall away with this bullish divergence.
Hence, the trader would have been wise to avoid entering a long position on the price of the S&P 500. What was interesting for the trader to see was that the MACD line crossed over the signal line from the top.
As we mentioned above, a signal line crossover from the top is a bearish crossover. This was a clear indication to the trader the price was about to fall.
Indeed, if the trader had shorted the S&P 500 index at this point he would have garnered an impressive return as downside momentum picked up. There was also another signal crossover that the trader could have used as an exit point for the trade.
The MACD is one of the most important indicators at the disposal of the technician. It allows the trader to get a healthy sense of not only the trend in the asset but also whether there is any momentum behind it.
There are also a number of other ways in which the MACD can be honed for different reading. A nonstandard setting can be used if the trader would like to adjust the sensitivity of the indicator.
We would, however, recommend the trader to use standard (12,26,9) MACD trading strategies with a shorter timeframe when entering shorter dated charts with more sensitivity.
Lastly, as with nearly everything in technical analysis, the use of only an individual chart or indicator is not optimal. The best traders combine a host of technical indicators to produce one concrete signal. This increases the chances of the signal being successful and the trader making a long term profit.