MACD Indicator Explained
The MACD is a trend following momentum indicator and it shows the relationship between two moving averages, and measures the distances between these two moving average lines. MACD is an acronym for Moving Average Convergence Divergence. The MACD indicator was developed by Gerald Appel 30 years ago and today the MACD Indicator remains one of the most popular indicators in technical analysis. MACD is a simple and very reliable indicator with multiple features. The best thing about this indicator is that it has a lot of multiple features and definitely it can be integrated into different trading strategies. In this article, you’re going to learn more than just the indicator structure, but you’ll also learn how to incorporate it in your own strategy.
MACD Indicator Explained
There are three components that constitute the MACD indicator:
- The first one is the MACD line itself, which is the difference between two moving averages;
- A signal line;
- A histogram;
By default the MACD line is the 12 day MA minus the 26 day Exponential MA. The signal line by default is the 9 EMA of the MACD Line. Last but not least the histogram represent the difference between those two lines (MACD line – Signal line). So the most common settings for MACD indicator is 9, 26, 10:
- Short EMA: 9;
- Long EMA: 26;
- Signal Line: 10;
In order to put more clarity on how to interpret the MACD indicator lets have a look at the chart below. Naturally, you would expect when the two moving averages cross over that the MACD line, which is the difference between 12EMA and 26EMA, will be at zero. The signal line is basically tracking that difference on a 9 day EMA, and then the histogram itself is showing where those two lines cross over.
How to use the MACD Indicator
Any individual indicator on its own is just not enough for picking a trade, so it’s just part of an overall set of tools in the process that you might use when trading. No matter what type of trader you’re this indicator can be useful in gauging the market on all time frames. Going forward you’re going to be introduced on how the MACD indicator can be used:
- When the MACD line crosses the signal line;
- When the MACD line crosses above the Signal line it suggests the trend has turned up;
- Zero on the histogram is the point that delimits the up trend versus the down trend;
- When the MACD line turns down through zero, it suggests we enter in a bearish trend;
- Center line method
- When the MACD line actually crosses over zero, which confirms that the trend direction has changed and could be accelerating;
The disadvantages using these two particular approaches are that in a sideways market, we can get whipsawed in and out of the market which can be extremely frustrating. In this regard, the best way to use the MACD indicator is to use the divergence method. When the MACD diverges from the price action, it’s a much more reliable signal the an end of the trend. As you know most indicators are lagging in nature because they use historical price to give you the output, therefore the only way to use the MACD as a leading indicator, which means that it can tell us beforehand where the market is going to move, is to use the divergence method.
Let me put it simply, divergence means that the price is moving in the opposite direction of the MACD indicator. When the market is moving higher, making higher highs while the MACD is moving downward and making lower highs, in this case, we have a negative divergence. The MACD is trying to tell us that the market is going to move down. On the other hand, when the market is moving down, making lower lows while the MACD is moving upwards, making a higher low, in this case, we have a positive divergence and the MACD is trying to tell us that the market is going to move up.
Using the MACD indicator it can be a good way of knowing when the price is going to move and, therefore, it can serve as a good entry signal, you may want to consider adding the MACD indicator in your trading system as a way to confirm your entry signals.
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