If you’re a trader applying technical analysis to help with opening and closing your positions, chances are you will encounter the much-used MACD indicator. Discover here what MACD is, how it is calculated, and how to apply MACD in the markets.
What is MACD?
MACD is a popular technical indicator used by traders to help with their analysis. It shows the relationship between two moving averages of a security’s price and can help make more sense of trends and momentum, combining a MACD line, signal line and histogram to give bullish and bearish signals.
What does MACD stand for?
MACD stands for Moving Average Convergence Divergence. The name refers to the difference between two exponentially-levelled moving averages of a security’s price, and how this resulting line (the MACD line) diverges from and converges with its signal line (an exponentially-smoothed average of the MACD line).
What are moving averages?
Moving averages refer to lines representing the value of prior data over an average period, to give traders a measure of momentum, as well as to grade trends. For example, a 50-day moving average will show the average price of a security over the past 50 days, while a 200-day moving average will show the price over the past 200 days.
Traders can refer to multiple moving averages to gain better information about short and long-term trends. They will often use crossovers for bullish or bearish signals. When the short-term average crosses above the longer-term average, this is known as a ‘golden cross’ and is seen as a bullish signal. When the shorter-term average crosses below the longer-term, this is known as a ‘death cross’ and is seen as a bearish signal.
However, moving average crossovers may not be sufficient to use by themselves as they are often lagging (meaning they trail the current price) and can give off false signals in range-bound, as opposed to trending, markets.
With these downsides in mind, MACD gives more information on the relationship between two given moving average values to offer more insight for traders to consider before making entries and exits.
How to read MACD
When it comes to how to read MACD, you need to be aware of the MACD line, the signal line, and the histogram, and how they interact to create signals.
The MACD line is the value calculated by subtracting the shorter period exponential moving average from the longer period. It will grade the deviation between these values. Often, the respective time periods of these EMAs is 12 and 26.
As the divergence between the moving averages increases, the value of the MACD line becomes stronger.
Meanwhile, the signal line is a moving average applied on the MACD line, and adds depth to the indicator. The signal line generally shows a 9-period smoothed average of the MACD line.
Finally, the histogram shows the relationship between the MACD line and the signal line.
When the MACD line crosses above the signal line, the value of the histogram goes above the zero line, and this is usually seen as a bullish signal. The further the MACD line diverges above the signal line, the more the histogram value will increase. When the MACD line crosses below the signal line, the value of the histogram will go below the zero line, and this is seen as bearish. The further the MACD line diverges below the signal line, the more the histogram value will decrease.
How to use MACD
When it comes to how to use MACD, traders should be aware, that the MACD line crossing above the signal line is generally seen as a bullish signal. This means that – depending on other technicals and fundamental analysis – they may want to consider opening a long position when this happens.
Conversely, when the MACD line drops below the signal line, this is generally seen as a bearish signal, and may prompt traders to consider a short position.
The MACD histogram can be tracked as its bars grow larger and the MACD line diverges from the signal line. When the histogram produces a smaller bar, traders can consider an entry in the direction of the histogram’s decline, whether below the zero line (long) or above the zero line (short).
MACD step by step guide
To get started using MACD, take a look at our step-by-step guide for easy application to your charts.
- Open the MACD indicator on your chart.
- Adjust the values of the short and long-period EMAs, and the signal line, as necessary. The default is usually 12 and 26-day periods, but those looking for more sensitivity may try shorter short-term and a longer long-term (for example, 5,35,5).
- In conjunction with other technical and fundamental strategies outlined in your trading plan, identify long or short opportunities based on the activity of the MACD line, signal line and histogram. For example, the MACD line moving above the signal line may influence an entry long.
- Exit trades based on the same criteria, again in conjunction with your strategy. For example, the MACD line moving below the signal line may be an exit (short).