Acquiring proficiency in the MACD indicator can be a significant asset for any trader looking to level up their technical analysis. The MACD indicator can help you find trends, assess momentum in your trading instrument, and give you potential entry and exit points for your trades. The process of learning how to use MACD indicator will improve the technical analysis of any trader, novice to seasoned, and is a vital step in mastering the online stock market.
What is MACD Indicator?
The Moving Average Convergence Divergence (MACD) indicator is one of the widely used momentum indicators that follow a trend. It is used explicitly to measure the relationship between two moving averages of an asset's price. The greatest thing about the MACD is that it offers momentum and trend in one indicator.
The MACD indicator consists of three elements:
The MACD Line: This faster line on your chart is simply the difference of the 26-period Exponential Moving Average (EMA) from the 12-period EMA.
The Signal Line: This is the slower line and is a nine-period EMA of the MACD Line, meaning it essentially acts as an indicator for potential buy and sell signals.
MACD Histogram: This is a visual component that shows the difference between the MACD Line from the Signal Line. The higher the histogram bars get, the more the momentum increases, and the smaller the histogram bars get, the less the momentum increases.
How to Read the MACD Chart?
The most important aspect of reading the MACD chart is understanding the Zero Line. The Zero Line is the horizontal line that runs through the chart and serves as an anchor for momentum.
Above Zero Line: When the MACD and Signal lines are both above the Zero Line, this indicates bullish momentum. This means the 12 EMA is above the 26 EMA, indicating bullish momentum. The market is in an uptrend.
Below the Zero Line: When the lines are below the Zero Line, this indicates bearish momentum. This means the 12 EMA is below the 26 EMA, indicating bearish momentum. The market is in a downtrend.
The histogram is a visual representation that makes this easy to interpret. Positive histogram bars (above the Zero Line) confirm bullish momentum; negative histogram bars (below the Zero Line) affirm bearish momentum.
If you would like to go further into chart analysis, check out the rest of our article on Candlestick Pattern.
Core MACD Trading Strategies
Reading the chart is just the first step. Below are the best MACD strategies you can implement. To master these and other advanced techniques, consider enrolling in our Advanced Technical Analysis Cert Course.
1. The MACD Crossover Strategy
This is the most popular and simplest way to use the MACD indicator. A crossover is when the MACD Line crosses over the Signal Line and vice versa.
Bullish Crossover (Buy Signal): This happens when the MACD Line crosses from below to peak above the Signal Line, confirming the price momentum of the asset is shifting to the upside and is likely to be a good time to take a long position.
Bearish Crossover (Sell Signal): This happens when the MACD Line crosses from above to peek below the Signal Line, confirming the price momentum is waning and is likely a good time to sell or take a short position. Know more about the Bearish Candlestick patterns.
2. The Zero Line Crossover
Another crossover signal to be aware of is when the MACD Line crosses the Symbolized Zero-Line.
Zero Line Bullish Crossover: The MACD Line crosses upward from below the Zero-Line, confirming a change from a bearish trend to a bullish trend.
Zero Line Bearish Crossover: The MACD Line crosses downward from above the Zero-Line, confirming a change from a bullish trend to a bearish trend.
3. MACD Divergence
Divergence is a strong signal that a trend reversal may be close at hand -- happening when the price of an asset is moving in the opposite direction from the MACD.
Bullish Divergence: The price drops to a new low, with the MACD printing a higher low. This shows a slowing downtrend, which means a possible upside reversal is nearing.
Bearish Divergence: The price climbs to a new high, with the MACD signaling a lower high. This tells of a slowing uptrend and the potential for a reversal in price, which could yield good results.
Optimizing Your MACD Indicator Settings
Typically, the MACD is set to the default of 12, 26, and 9. While this is a great setting for many cases, you can optimize based on your individual trading strategy.
Day Trading: Day traders might prefer faster settings (5, 35, 5) to generate signals and pick off short-term moves. This is key to thriving in Successful Intraday Trading Strategies for Beginners.
Swing Trading: A swing trader that holds for days/weeks might be using slower settings (20,40,10) to navigate out the white noise of the market and focus on the bigger, longer-term trend. Find out which one is better for you, Swing Trading vs Day Trading.
Ultimately, the correct settings you should use depend on your trading style, the timeframe in which you are trading, and the asset you are trading. Always backtest your settings on a demo account for some time before using it with your real capital.
Conclusion
As an indicator, the MACD indicator is a flexible and useful indicator for any trader's toolbox. By recognizing how its components work, how to read its signals, and how to implement strategies like using crossovers and divergence, you will remain in a better position in the markets. While no indicators can guarantee success, learn to utilize the MACD indicator for your trading along with other analyses to better your trade decisions and ultimately increase profitability.
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