What Is MACD in Stock Trading? A Detailed Guide for Beginners Starting to Trade

Basic Concepts of MACD

MACD (Moving Average Convergence Divergence) is one of the most widely used technical indicators in the field of financial trading, from forex, cryptocurrencies to stocks. This indicator was developed by Gerald Appel in 1979 and has become an indispensable tool for investors.

What is MACD in stocks? Essentially, MACD is a momentum indicator built based on the difference between two exponential moving averages (EMA). It helps traders identify market trend directions and find optimal entry points.

Structure and Components of the MACD Indicator

MACD Calculation Formula

The MACD line is determined by the formula:

MACD = EMA(12) – EMA(26)

Where:

• EMA(12): The 12-period exponential moving average (represented by the red line)
• EMA(26): The 26-period exponential moving average (represented by the green line)

When EMA(12) is above EMA(26), MACD has a positive value. Conversely, when EMA(12) is below EMA(26), MACD has a negative value. The larger the gap between the MACD line and the zero line (zero line), the stronger the trend, indicating greater market momentum.

Four Main Components of MACD

A complete MACD indicator includes:

1. MACD Line

• Its main role is to help determine the market trend
• Reflects changes in momentum between short-term and long-term prices

2. Signal Line (Signal Line)

• An EMA(9) of the MACD line itself (not the EMA(9) of the price)
• When combined with MACD, it generates important market reversal signals

3. Histogram

• Reflects convergence (convergence) and divergence (divergence) of the market
• Calculated as the difference between the MACD line and the Signal line
• Changes from negative to positive or vice versa to signal trend shifts

4. Zero (Baseline)

• Acts as an important reference line
• Helps investors assess whether the current trend is strong or weak

Key Signals from the MACD Indicator

Signal from MACD and Signal Line Crossovers

This is the most common signal used by traders:

Buy Signal:

• When the MACD line crosses above the Signal line from below
• Histogram shifts from negative to positive
• Meaning: Price is likely to trend upward

Sell Signal:

• When the MACD line crosses below the Signal line from above
• Histogram shifts from positive to negative
• Meaning: Price shows signs of decline, investors should consider selling

Signals from Zero Line Crossovers

Crossing from below to above:

• MACD crosses zero from below, turning positive
• Indicates EMA(12) > EMA(26)
• Signifies a strong bullish market signal

Crossing from above to below:

• MACD crosses zero from above, turning negative
• EMA(12) < EMA(26)
• Indicates a bearish market signal

Divergence and Convergence - Reversal Signals

Divergence (Divergence):

• Occurs when prices are rising but MACD is falling
• Warning sign that the price may reverse from uptrend to downtrend
• Investors should consider accumulating short positions
• Example: Bitcoin showed divergence signals before a sharp decline from $68,000

Convergence (Convergence):

• Forms when prices are falling but MACD is rising
• Indicates a potential reversal from downtrend to uptrend
• Investors have the opportunity to enter buy orders to maximize profits

Trading Strategies Using MACD

Basic Strategy

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

Buy Signal:

• Histogram shifts from negative to positive
• MACD crosses zero line from below
• Convergence signal appears

Sell Signal:

• Histogram shifts from positive to negative
• MACD crosses zero line from above
• Divergence signal appears

Combining MACD with Stochastic Indicator

The Stochastic indicator measures price momentum by comparing the closing price to the price range over a specified period.

Operating Principles:

• When Stochastic exceeds 80: Price is overbought, high likelihood of reversal
• When Stochastic drops below 20: Price is oversold, potential reversal

The Stochastic indicator consists of two lines:

• %K line: Main line
• %D line: 3-period moving average of %K

Double Cross Strategy:

When combining MACD and Stochastic, this strategy identifies simultaneous crossover signals from both indicators. This helps:

• More accurately determine trend reversals
• Find reliable entry points
• Minimize false signals

When a stock or asset shows simultaneous crossover signals from both indicators, the reliability of the signal significantly increases.

Combining MACD with RSI Indicator

RSI (Relative Strength Index) is another momentum indicator, measuring from 0 to 100 points, calculated by dividing average gains by average losses over a period (usually 14 periods).

Important Levels:

Overbought Zone:

• Usually starts at 70 points
• In a bull market (bull market), some investors use 75 or 80 for more accurate signals

Oversold Zone:

• When RSI exceeds 30 points, the market enters oversold territory, signaling a buy
• Some investors wait for levels 25 or 20 for added safety

Benefits of Combining:

MACD and RSI complement each other:

• RSI: Helps predict overbought or oversold zones
• MACD: Helps identify trend direction and find precise entry points

Example: When RSI is overbought and MACD crosses Signal downward, the sell signal is highly reliable.

Limitations of the MACD Indicator

Although MACD is a powerful indicator, it has some limitations:

1. False Signals

• Divergence or convergence can signal reversals but may produce false signals
• This can lead to losses if traders are not cautious

2. Subjective Factors

• Each trader can set MACD parameters differently
• Results depend on user settings
• Subjectivity can cause errors

3. Lagging Phenomenon

• MACD tends to lag behind actual market changes
• Leading to delayed signals compared to real market movements

Frequently Asked Questions

How to reduce false signals?

An effective method is to use multi-timeframe analysis:

• Use higher timeframes to identify the main trend
• Use lower timeframes to spot potential trading signals
• This approach filters out many false signals

What are the optimal settings for MACD?

Default settings 12, 26, 9 are proven effective. However, you can adjust:

• Use longer timeframes for more consistent signals
• For example, change to 21, 55, 9 to suit your trading style

Which timeframe should I use for MACD?

There is no absolute best timeframe. It depends on:

• Your trading style (short-term or long-term)
• Asset type (crypto, stocks, commodities)
• Personal profit goals

Conclusion

MACD is a complex but extremely useful tool in any trader’s arsenal. Despite its limitations, its popularity and effectiveness in identifying trends and predicting reversals are undeniable.

The MACD indicator is available on most modern trading platforms. To master this technical indicator, investors should:

• Study the underlying theory of MACD thoroughly
• Practice on demo accounts before live trading
• Combine MACD with other indicators to increase reliability
• Manage risks appropriately in all trades

Continuous learning and practice will help you use MACD effectively to maximize your trading profits.