MACD - An Essential Technical Indicator for New Investors

Discovering the MACD Indicator and Its Application in Trading

The MACD (Moving Average Convergence Divergence), invented by Gerald Appel in 1979, has become one of the most popular technical analysis tools in modern financial markets. From forex trading, cryptocurrencies to stocks, the MACD is favored by investors for predicting price trends and identifying optimal trading points.

Structure and Operating Principles of MACD

The MACD is calculated based on the difference between two exponential moving averages (EMAs) with periods of 12 and 26:

MACD = EMA(12) – EMA(26)

When the EMA(12) is above EMA(26), the MACD is positive. Conversely, when EMA(12) is below EMA(26), the MACD is negative. The greater the distance from the zero line (zero line), the larger the gap between the two EMAs.

A complete MACD indicator consists of four main components:

• MACD Line: Helps investors identify the trend direction of the market
• Signal Line: An EMA(9) of the MACD line (not an EMA of the price), used together with MACD to generate reversal signals
• Histogram: Reflects the convergence or divergence between the MACD line and the Signal line
• Zero (Base line): A reference line to assess the strength or weakness of the trend

Trading Signals from MACD

Crossovers Between MACD and Signal Line

This is one of the most important signals traders should watch:

• When the MACD crosses above the Signal line (Histogram shifts from negative to positive), it signals a buy, indicating an upward price trend
• When the MACD crosses below the Signal line (Histogram shifts from positive to negative), it signals a sell, indicating a potential downward trend

MACD Crossing Zero Line

Crossing the zero line also carries significant meaning:

• When MACD crosses above zero from below, the MACD value turns positive (EMA(12) > EMA(26)), indicating a bullish signal
• When MACD crosses below zero from above, the MACD becomes negative (EMA(12) < EMA(26)), indicating a bearish signal

Convergence and Divergence

Divergence occurs when the price is rising but the MACD is trending downward. This warns that the price may reverse from an uptrend to a downtrend. A typical example is when BTC sharply declines from the $68,000 peak after divergence signals appear.

Convergence occurs when the price is falling but the MACD is rising, indicating a potential reversal from a downtrend to an uptrend. This is an ideal time for investors to consider buying.

Trading Strategies with MACD

Basic Strategy

Based on the three main signals of MACD, traders can develop trading strategies:

Buy signals:

• Histogram shifts from negative to positive
• MACD crosses above zero line from below
• Convergence signals appear

Sell signals:

• Histogram shifts from positive to negative
• MACD crosses below zero line from above
• Divergence signals appear

Combining MACD with Stochastic Indicator

The Stochastic oscillator measures momentum by comparing the closing price to the price range over a specific period. When combined:

• Stochastic > 80: Overbought zone, high likelihood of reversal
• Stochastic < 20: Oversold zone, potential upward reversal

The Double Cross strategy combines both indicators; when both MACD and Stochastic generate crossover signals simultaneously, the accuracy of predicting reversals significantly improves.

Combining MACD with RSI Indicator

The RSI (Relative Strength Index) is also a momentum indicator, calculated by dividing average gains by average losses over a period (usually 14 periods).

• Overbought zone: 70 points or higher, some traders use 75 or 80 for confirmation
• Oversold zone: Below 30 points, some wait for 25 or 20

MACD and RSI complement each other: RSI detects overbought/oversold conditions, while MACD identifies trend direction and entry points more precisely. When RSI is in the overbought zone and MACD crosses below the Signal line, it’s a very strong sell signal.

Limitations of MACD

Although MACD is an effective tool, traders should be aware of some limitations:

• False signals: Divergence/convergence may not always be accurate, potentially leading to false signals and losses
• Subjectivity: Each trader can set different MACD parameters based on their goals, resulting in varied outcomes
• Lagging: MACD can be delayed in its crossovers, causing signals to lag behind the actual trend

Tips for Using MACD

How to reduce false signals?

A practical approach is multi-timeframe analysis. Use higher timeframes to identify the main trend and lower timeframes for specific trading signals.

What settings should be used for MACD?

While the default settings are 12, 26, 9, traders can adjust them for better suitability. For example, changing to 21, 55, 9 may produce more consistent signals on longer timeframes.

Conclusion

The MACD indicator is a powerful tool in technical analysis, helping traders identify trend directions, predict reversals, and optimize trading timing. Despite some limitations, its popularity and effectiveness in trading are undeniable. To master MACD, traders should practice regularly, combine it with other indicators, and apply it on reliable trading platforms.