After all, all the data used in MACD is based on the historical price action of the stock. However, some traders use MACD histograms to predict when a change in trend will occur. For these traders, this aspect of MACD might be viewed as a leading indicator of future trend changes. When MACD forms highs or lows that exceed the corresponding highs and lows on the price, it is called a divergence.
How this indicator works
If MACD crosses above its signal line after a brief downside correction within a longer-term uptrend, it qualifies as a bullish confirmation and the likely continuation of the uptrend. A moving average divergence can signal a possible reversal, but no actual reversal produces a false positive. False positive divergences often occur when the price of an asset moves sideways in a consolidation, such as in a range or triangle pattern following a trend. Both measure momentum in a market, but because they measure different factors, they sometimes give contrary results.
What is the MACD trading strategy?
The histogram is used as a good indication of a security’s momentum. It calculates the difference between a security’s 26-day and 12-day exponential moving averages (EMA). Each moving average uses the closing price of its period (26- and 12-day) to calculate its moving average value. This article discusses how to read MACD, divergence, price action, trend direction, and momentum. These common trade tactics are the backbone of a full trading strategy. Now that we have identified what the names represent, we can decipher how to read MACD and what the moving average convergence divergence signals are made of.
What is the MACD indicator?
As a result, the picture below a candle stick chart shows the 26EMA and 12EMA. As mentioned earlier, the MACD indicator is calculated by taking the difference between a short-term moving average (12-day EMA) and a longer-term moving average (26-day EMA). Given this construction, the value of the MACD indicator must be equal to zero each time the two moving averages cross over each other. Traders may buy the security when the MACD line crosses above the signal line and sell—or short—the security when the MACD line crosses below the signal line. MACD indicators can be interpreted in several ways, but the more common methods are crossovers, divergences, and rapid rises/falls. The MACD line is calculated by subtracting a long-term exponential moving average (EMA) from a shorter-term exponential moving average.
A crossover occurs when the signal and MACD line cross each other. The MACD generates a bullish signal when it moves above its own nine-day EMA and triggers a sell signal (bearish) when it moves below its nine-day EMA. On the MACD chart, a nine-period EMA of the MACD itself is also plotted. It acts as a trigger for buy and sell decisions when the MACD crosses over it.
Traders use rapid rises or falls in the MACD line as a signal the stock is overbought or oversold. When stocks are overbought or oversold, it is generally accepted volume traded will return to ‘normal’ levels. The first is at around the $55 level, when the MACD line fell beneath the signal line.
Hence, there is a need to understand 100% before taking a trade. The MACD line is the measurement between two moving averages, as presented above. When those two moving averages move toward each other, they converge. When learning how to read MACD, the Avg Line has a default setting of 9EMA. If you look back at the picture of the user dialog box, you’ll see a Fast Length, a Slow Length, and a MACD length.
Traders are misled into believing they can profit from this indicator. In yet another bearish sign for the E-mini S&P 500 futures contract, the future made higher lows from Low #1 to Low #2, which again is usually considered positive. Notice in this example how closely the tops and bottoms of the MACD histogram are to the tops of the Nasdaq 100 e-mini future price action. When a stock, future, or currency pair is moving strongly in a direction, the MACD histogram will increase in height. This occurs because the MACD is accelerating faster in the direction of the prevailing market trend.
Divergence could also refer to a discrepancy between price and the MACD line, which some traders might attribute significance to. Simply put, divergence is when the MACD and actual price are not in agreement. The MACD indicator is typically good for identifying three types of basic signals; Signal Line Crossovers, Zero Line Crossovers, and Divergence. A general interpretation of MACD is that when MACD is positive and the histogram value is increasing, then upside momentum is increasing. When MACD is negative and the histogram value is decreasing, then downside momentum is increasing. Aspray’s contribution served as a way to anticipate (and therefore cut down on lag) possible MACD crossovers which are a fundamental part of the indicator.
Traders generally believe that the value of the RVI increases as a bullish trend continues to gain momentum. That’s because, in this case, an asset’s closing price tends to fall at the higher end of the range. The opening price, on the other hand, stays further down on the lower end of the range. Divergence refers to a situation where factors move away from or are independent of others. With the MACD, it is a situation where price action and momentum are not acting together. Each day we have several live streamers showing you the ropes, and talking the community though the action.
No, the MACD indicator is inaccurate; it causes many small losses and misses good entry points. Backtesting the MACD indicator on 30 Dow Jones Industrial Average stocks over 20 years resulted in a 26% win rate, meaning it underperformed a buy-and-hold strategy 76% of the time. It is essential to note that the values for each moving average are adjusted over time, so the MACD line will continuously change.
A MACD crossover of the zero line may be interpreted as the trend changing direction entirely. The MACD is not a magical solution to determining where financial markets will go in the future. Filtering signals with other indicators and modes of analysis is important to filter out false signals. Some traders, on the other hand, will take a trade only when both velocity and acceleration are in sync. Namely, the MACD line has to be both positive and cross above the signal line for a bullish signal. Or the MACD line has to be both negative and crossed below the signal line for a bearish signal.
The MACD is considered the faster line because the points plotted move more than the signal line, which is regarded as the slower line. It is one of the most popular technical indicators in trading and is appreciated by traders worldwide for its simplicity and flexibility. Each day our team does live streaming where we focus on real-time group mentoring, coaching, and stock training.
Remember, moving averages and all their variations are trailing indicators. It might be more accurate to use the MACD to confirm a reversal than to spot one. Here’s where traders use the concept of divergence to make an educated guess about possible reversal. I caution you against blindly accepting what other traders say when it comes to using technical indicators.
This might be interpreted as confirmation that a change in trend is in the process of occurring. The zero-cross strategy could be used again to take a long position when the MACD crosses the zero line from below. At the point circled in our image, prices have been rising and momentum is up. As trading proceeds, you observe the MACD initially crossed the zero line from below, then crossed again from above.
The stock price then dropped dramatically to about the $35 level in a matter of a few trading days, when another sell signal triggered a new series of down days. Prices fell to the mid-teens over a period of about two months. While the MACD is a popular momentum indicator, it is not enough by itself to accurately forecast price trends. Experienced traders a variety of metrics in order to support their predictions. However, chart analysis isn’t as simple as looking for crossovers on a graph.
The top curve represents the price chart for a hypothetical security, along with a set of trendlines. The middle chart is a MACD line and histogram, centered around a baseline. The lower histogram represents the volume for each trading period. Zeroes in the MACD histogram occur when the MACD line crosses higher than the signal line (generally considered a buy signal) or below the signal line (a sell signal). Peaks and troughs in the histogram indicate when a burst of bearish or bullish momentum is losing strength, and the curve is likely to return to its mean. Traders use the MACD histogram to identify potential trend reversals and price swings.
However, one signal it does offer alone is the slope or market trend direction. When the Value line is pointed up, the price is on an uptrend. Likewise, if the value line points down, the price is downtrend.
Also, the entry and exit prices use an average of the high and low prices for the day, making the testing more realistic. The histogram can also identify divergences between price and MACD Line movements. When prices increase while the MACD Line decreases simultaneously, it is known as a bearish divergence and is seen as a bearish sign that could indicate a potential sell signal.
Using the power of TrendSpider’s backtesting engine, we can scientifically test the accuracy and success rate of the MACD indicator and the optimal settings. My analysis, research and testing stems from 25 years of trading experience and my Financial Technician Certification with the International Federation of Technical Analysts. When that occurs, the MACD line is getting closer to the MACD signal line. I became a self-made millionaire by the age of 21, trading thousands of Penny Stocks – yep you read that right, Penny Stocks. The weapon of choice is knowledge and an excellent way to improve your knowledge is with the Trading Challenge.
Look at the slope of the Value line and the length of the Diff Swabs. When learning how to read MACD, the MACD Study shows two lines and a histogram of the distance between those two lines. Centerline crossover patterns are similar to signal line crossover patterns except that they involve only the MACD line and its relationship to the zero/center line. To set up backtesting, I used TrendSpider, our recommended trading software for serious traders. The screenshot below shows the exact configuration for our MACD backtesting.
The RSI may show a reading above 70 (overbought) for a sustained period, indicating a market is overextended to the buy side of recent prices. In contrast, the MACD indicates that the market is still increasing in buying momentum. Either indicator may signal an upcoming trend change by showing divergence from price (price continues higher while the indicator turns lower, or vice versa).
- If you look at our original chart, you can see that, as the two moving averages (MACD Line and Signal Line) separate, the histogram gets bigger.
- That said, you know I’m about to give you the push to study, study, study.
- Part of the reason why technical analysis can be a profitable way to trade is because other traders are following the same cues provided by these indicators.
- After all, all the data used in MACD is based on the historical price action of the stock.
The signal line is calculated by taking the difference between the two EMAs, and from that number create a nine-day moving average. Using only the MACD signal line for entry and exit indicators can be noisy and give false signals. Traders often pair the MACD with other indicators to seek confirmation before executing trading signals. Adjusting the number of periods in the EMA calculations changes the MACD’s speed of responsiveness to price changes. Reducing the responsiveness of the MACD line gives fewer signals, which can reduce whipsaws but comes at the expense of quicker entry and exit signals.
The Moving Average Convergence/Divergence indicator is a momentum oscillator primarily used to trade trends. Although it is an oscillator, it is not typically used to identify over bought or oversold conditions. It appears on the chart as two lines which oscillate without boundaries.
Many individual traders, as well as institutional traders, investors and fund managers use the MACD to figure out more about where a stock price is likely to go in the immediate future. If you are considering using this traditional charting tool to make stock decisions, here are some common steps to help you read the MACD. The MACD and RSI are both trend-following momentum indicators often used in tandem to give analysts and traders a better technical understanding of market conditions.
This bullish crossover suggests that the price has recently been rising at a faster rate than it has in the past, so it is a common technical buy sign. Traders often combine this analysis with the RSI or other technical indicators to verify overbought or oversold conditions. The best settings for the MACD indicator generally depend on the trader’s strategy and market conditions.
This gives us a great signal of price reversal since we use moving average cross-overs to signal when the price has changed direction. Technical analysis focuses on market action — specifically, volume and price. Technical analysis is only one approach to analyzing stocks.
The MACD indicator is the most popular tool in technical analysis because it gives traders the ability to quickly and easily identify the short-term trend direction. The MACD rapid rises or falls occur when the underlying short-term moving average pulls away from the long-term moving average and may signal an overbought or oversold condition. Developed in 1979 by Gerald Appel, the MACD indicator measures the difference between two exponential moving averages (EMAs) of closing prices. The convergence and divergence of the two moving averages are measured. The further apart the lines are, the greater the momentum or strength of the trend.
Over 20 years, a buy-and-hold investor would have made 39,975% with Apple, but a MACD trader would have made only 961%. Testing the standard MACD settings on a daily candlestick/OHLC chart proves this indicator is poor, with 29 (97%) of the 30 DJIA stocks failing to beat a buy-and-hold strategy. Using a Heikin Ashi chart, the results were still weak, with MACD beating a buy-and-hold strategy only 26% of the time. Only 40% of MACD trades were profitable, and the spread between winning and losing trades was 0.2%. This means MACD is an incredibly poor indicator for day traders. As you can see, while the day trading margins were tight, the Heiken Ash chart was a better setting for day trading than the OHLC candles.
But if they say it enough and everything else lines up right, the stock might make a brief run. Some traders wait for the MACD line to also break above the zero line as confirmation of momentum shift. You can see an example of this (labeled zero line confirmation) on the CANB chart above. The third part of the MACD indicator is the divergence line or zero line (depending on which convoluted definition you pay attention to). The reason the MACD is considered a momentum oscillator is because it oscillates around the zero line. The MACD histogram is calculated by subtracting the signal line from the MACD line.
These signals are clear and offer an opportunity to anticipate a move before the breakout. This indicator has great swings above and below the Zero Line. The Value Line presents more signals than just being above or below the average line.
Its importance in trading cannot be overstated as it combines elements from different trading indicators to provide a comprehensive view of price movements. Understanding MACD is crucial for both new and experienced traders aiming to enhance their trading strategy. I don’t consider the moving average convergence divergence a trade signal indicator because I don’t consider a moving average crossover a trade entry signal. how to read the macd The Impulse MACD Indicator is a technical analysis tool, designed to filter out noise and focus on significant trend changes. The Impulse MACD typically modifies the MACD by applying a color code to the MACD histogram bars, where different colors indicate buying or selling impulses. This helps traders identify potential entry and exit points by highlighting changes in momentum more clearly than the standard MACD.