Feeling like a fish out of water in the world of crypto trading? Learn how to use the MACD indicator to make sense of those squiggly lines!
With so many indicators to choose from, it can be difficult to figure out what is right for you. On the agenda for this article is the MACD indicator, one of the most popular indicators in trading that is relatively easy to use.
What Is the MACD Indicator?
The moving average convergence divergence indicator – or MACD for short – is what they call an oscillator-type indicator that has managed to gain significant popularity in the trading industry.
Gerald Appel developed MACD in 1979 as a trend-following indicator to determine the momentum of an asset. It is based on price action that has already happened and is, therefore, considered a lagging indicator. Nevertheless, traders find it useful to study both the strength of a trend and its direction – even using it to determine potential trade entries and exits.
As the name of the indicator suggests, the moving average convergence divergence indicator uses multiple moving averages to generate its output. Before we dive into the technicals of the MACD indicator, let us briefly look back at what moving averages are.
A moving average (MA) is a technical indicator that shows the average price of a predetermined number of candles. For example, a 50-day moving average calculates the average price for the last 50 daily candles. To do this, the closing price of each candle is used.
While leaving the calculation roughly the same, exponential moving averages apply more weight to the recent price action before computing the average price over a given period.
Read more on moving averages in this article.
How Does the MACD Indicator Work?
As discussed, the MACD indicator uses different moving averages to generate its output. Specifically, it subtracts two exponential moving averages (EMAs) to generate the MACD line. The second line is then based on this MACD line, generating another EMA.
With these two data points, the histogram is calculated using the distance between these two EMAs. When the MACD line trades above the signal line, the histogram is positive. Whereas it goes negative when the MACD line trades below the signal line. We will dive into what that means for your trading decisions later on.
In sum, the MACD indicator has three distinct, key elements:
The MACD line (1) helps determine the market trend. This line is an EMA, calculated by subtracting two different exponential moving averages, usually the 12 and 26-period EMAs. This period is dependent on the time frame you are charting. For example, the indicator will use the 12-day and 26-day EMAs when looking at the Bitcoin daily chart.
The signal line (2) is meant to show the reversals in price action. It is a 9-period EMA of the MACD line.
The histogram (3), as discussed, shows the distance between two EMAs in the indicator. This helps to understand the momentum in the market, and whether or not it is slowing.
How To Use MACD in Trading?
With the MACD line, the signal line and the histogram, traders can derive all sorts of signals; ranging from MA crossovers to divergences. Let’s dive into these signals, and how you can use them in your trading!
Zero Line Crossover
Let’s start with a simple one - the zero-line crossover is one of the easiest signals to read and interpret. This signal appears when the MACD line crosses the zero level. When the line moves towards the positive digits, the trend is considered bullish, whereas it is bearish when it dips into the negative zone.
This signal is usually used in combination with the signal line crossover.
Signal Line Crossover
In this case, the signal line and MACD line cross paths. When the MACD line crosses above the signal line, it is considered a bullish sign – whereas a cross below the signal line is considered bearish.
MACD Divergences
The final signal presented by the MACD indicator is a tad more complicated. If you’ve read our article on the Relative Strength Index, you might recall the concept of divergence. MACD divergences are quite similar, as they occur when the MACD highs or lows diverge from price action.
For example, if the price of Bitcoin prints a lower low and the MACD fails to do so – it can be called a MACD bearish divergence. This is a signal that shows the downtrend is losing steam, and a reversal is looming. When this signal presents itself in combination with other signs of a reversal, it can serve as a strong buy signal.
Alternatively, if Ethereum’s price action creates a higher high while the MACD prints a lower high, a MACD bearish divergence presents itself. This shows exhaustion in the bullish trend, suggesting that a reversal is on the table. Again, if this signal presents itself in combination with other reversal signs, it can serve as a strong sell signal.
None of these signs should be taken at face value. After all, trading indicators are not exactly science, and there are false signals printed on charts from time to time. We recommend looking for confluence across multiple forms of analysis. When these analyses point in the same direction, traders can make well-informed decisions with a lower likelihood of false signals.
Closing Thoughts
All in all, the MACD indicator is a great tool for trading practices. It is quite simple to use and gives meaningful insights into the momentum and direction of trends.
While the MACD indicator – as any other indicator – can provide false or misleading signals, it can still be particularly useful when used in combination with other indicators and traditional technical or fundamental analysis.
Writer’s Disclaimer: This article is based on my limited knowledge and experience. It has been written for educational purposes. It should not be construed as advice in any shape or form. Please do your own research.
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