The MACD indicator is, without question, one of the most powerful indicators that traders can readily incorporate into their strategies. The indicator can signal price reversals and offer insight into the market’s trading momentum, allowing investors to make profitable trades throughout the year.
This technical analysis tool is also surprisingly easy to use and leverage, making it one of the most popular indicators today. The MACD indicator’s settings can also be adapted to better fit specific trading strategies, making it an equally versatile and potent tool in a trader’s arsenal.
The MACD Indicator
The MACD indicator, also known as Moving Average Convergence Divergence, studies the relationship between two exponential moving averages to illustrate market momentum and price reversals. These Exponential Moving Averages (EMAs) periods are adapted to better fit a trader’s strategy, with the most common setting being a subtraction between a 26-period and 12-period EMAs.
A technical analysis tool plots the resulting MACD line alongside a signal line so traders can study their crossovers. If the MACD line crosses above the signal line, it indicates that the market is on an uptrend, and if it crosses below it, it points out a downward momentum. A histogram is also plotted to easily visualize the market’s momentum and any divergences between the MACD indicator and the price action.
Before we incorporate the MACD indicator into our technical analysis toolbox and strategies, let’s take a closer look at its components. That way, we’ll know which settings best adapt to our trading strategies and goals.
Moving Average Convergence Divergence
The moving average convergence divergence has four components: the MACD line, the Signal line, the Histogram, and the MACD zero line. Let’s quickly go over each of these MACD chart components and create a brief MACD definition we can use for our technical analysis needs. For simplicity’s sake, we’ll assume we’re using the traditional 26 and 12-period Exponential Moving Averages for our calculations.
MACD Signal Line
The MACD line is calculated by subtracting the 26-day EMA from the 12-day EMA, while the Signal line is a 9-day EMA of the MACD line. The signal line reacts slower to price changes and has a smoother curve and overall appearance. The signal line is an essential part of the MACD indicator and the corresponding histogram.
The MACD Histogram, on the other hand, serves as a visual representation of the gaps between the MACD and Signal line and is composed of multiple easy-to-see bars. Your charting tool subtracts a Signal line value from its matching MACD line value and turns the result into a green or red bar. The MACD histogram also has a zero line representing the center of the MACD indicator. This line allows the histogram to indicate positive and negative values, which occur when the MACD line crosses above or below the Signal line.
Now that we know each of the MACD indicator’s components let us create a very brief, no-nonsense definition that we can use. Then, we’ll go over different ways to use the MACD indicator in our technical analysis.
The MACD, also known as Moving Average Convergence Divergence, is a trading reversal and momentum indicator. The indicator compares two exponential moving averages to predict profitable market turning points.
How To Use MACD Indicator
Learning how to use the MACD indicator is, thankfully, fairly simple. Traders will find that a MACD chart has many uses and can fit into numerous strategies with just a few settings adjustments. Most use it as a momentum and market reversal indicator, but we’ll also teach you how to use it as an entry and exit indicator. We’ll also review the MTF MACD indicator and how you can make profitable trades with a surprisingly high success rate.
As always, you’ll want to identify the overall market trend and support and resistance levels. Identifying the current market trend is easy enough: add a simple 200-day moving average, check the stock’s EPS (if applicable) and scan your MACD histogram for strong bearish, or bullish momentum. Next, you’ll want to track the price action and how it approaches resistance or support levels, as well as large body candles since they can indicate a future market reversal.
Candle patterns are, without question, a topic that is best thoroughly handled in their own article. To keep it brief, consider that strong, bold moves are better for shorting a position, whereas price action that slowly builds to resistance levels carries less momentum. If you notice that the price action inches towards resistance levels and registers higher highs and higher lows, it lacks the momentum we’re looking for. The opposite applies to long positions.
Once you’ve identified a strong bearish momentum in your MACD histogram, then you’ll want to consider entering the trade. Entering against a short-term market trend is a move you need to carefully consider before fully committing, which is why you should consult other stock indicators to truly get a sense of what’s happening.
Large candle bodies and sharp price action movements are, however, strong indicators that the market tends to reverse quite quickly. Take a look at Figure 2-1 above and notice the strong bearish momentum and how it’s quickly moving into the support zone (blue horizontal line). You can enter the trade and set your stop losses and profit target to add an effective trade to your portfolio.
Later in this piece, we’ll show an additional trick you can use to time your market entries and exits way before an abrupt market movement ends.
Using the MACD Indicator for Short and Long Positions
The MACD indicator is also useful for day traders and those who like to make a living from chasing trends in smaller timeframes. For instance, if you’re trading on a daily timeframe, you can look at the MACD lines and their histogram activity on a weekly timeframe to choose whether you should go long or short on your next trade.
Figure 4, specifically on march 26th, shows how the MACD line dips below the Signal line. This clue tells us to consider a short position soon, especially because you’d be following the current trend (downward trend). Since you’re already using the MACD indicator to predict market reversals, you might as well use it to track current trends.
To scan for live-action trends, you can also use shorter timeframes. For instance, if you’re trading on a four-hour timeframe, you can look at the daily trades timeframe, or if you’re a day trader, you could observe a four-hour timeframe to trade with hourly price actions.
Experienced traders agree that this indicator is often the last missing piece before pulling the trigger on a short or long position. It’s a neat MACD indicator application with a high success rate that you should definitely consider for your next trades.
Trading Breakouts with the MACD
The next MACD indicator application is controversial since many traders avoid breakouts and their uncertain nature altogether. Earlier, we talked about how the MACD, in conjunction with candle patterns, is used to predict market reversals right as they’re about to happen. However, if you’re looking to hit the jackpot on breakouts, you’d avoid huge momentum activity on your MACD histogram chart (because the move has already occurred, and you missed it).
Instead, you’ll want to look for price action buildup near a relevant market structure, such as a support or resistance zone. A price action buildup is easily recognizable because it comes with low to no momentum in its histogram chart and a tight consolidation pattern at the stock’s price chart. Take a look at an example pictured in figure 3 below.
Notice how the histogram shows little to no momentum, before the breakout, with price action nearing the resistance level before it finally breaks out. Sometimes, information and news come out shortly before a breakout, such as in the oil collapse of 2014. Still, more often than not, you’re better off scanning the market’s price action before committing to a position during a breakout.
Using the MACD as a volatility indicator offers tremendous trade opportunities, especially if you incorporate other stock indicators as part of your analysis while catching the move in its early stages. Worst case scenario, the indicator will tell you if you’re late to the move and save you considerable headaches and losses. Next, let’s look at the MTF MACD indicator and how we can use it for our technical analysis and trading strategies.
The MTF MACD Indicator
The MTF MACD indicator stands for Multi Timeframe Moving Average Convergence Divergence. This trading strategy and its indicators allow us to get a multi-timeframe perspective of a trend. It is most effective when used in a 5-minute timeframe of the price data, making it one of the most powerful tools for day traders and traders that are carefully monitoring a potential breakout or price reversal.
The strategy for the MTF MACD indicator uses two Exponential Moving Averages: a 50-period EMA and a 15-period EMA. When the 15min EMA is under the 50min EMA, we’ll approach a trade with a short bias, and when the 15min EMA is over the 50min EMA, we’ll choose a long position. Once you’ve found an appropriate trend direction, it’s time to look for a divergence with the MACD indicator.
For a short position, you’ll want to see a higher high on the price action and a simultaneous lower high on the MACD indicator. For a long position, we’ll need a lower low on the price action and a higher low on the MACD indicator.
If we’re looking to short during our next trade, we’ll also need both the MACD and Signal lines to stay above the histogram’s zero line. For a long position, we’ll instead look for a MACD and Signal line that stays below the MACD histogram’s zero line. These are almost self-explanatory requirements for the MTF MACD indicator strategy, but it requires further, more detailed observations from here on out.
Like so many other strategies, these are best explained while following an example. First, we’ll analyze a short position scenario to identify and visualize bearish divergences. Notice that the 15min EMA is under the 50min EMA and that we’ve identified a higher high on the price action and a simultaneous lower high on the MACD indicator.
Once you’ve spotted a suitable short position, you’ll want to see a bearish divergence with the following pattern (see: figure 7). Notice how both lines float, descend and come back up again without touching the histogram’s zero line. When that happens, you’ll immediately see a divergence with a higher high on the price action and a lower high on the MACD histogram. You’ll still be able to see the green and red bars on your histogram, but the lines won’t ever touch the zero line at any point.
The divergence serves as our entry signal, and in this case, we’ll take a short position with our respective stop-loss and target zones. Feel free to manage your risk-profit trades as you best see fit.
For a long position, we’ll need to look for a bullish divergence between the price action and the MACD. We’ll look for a lower low on the price action and a higher low on the MACD, as seen in figure 8 below. Notice that both the MACD and Signal lines never touch the zero line either, so it’s time we take the next cross-up as our entry signal.
Set your stop loss and targets as you enter the market swing, and you’re all set! Remember that several conditions must be met before you identify an entry signal, which makes this valuable tool a bit less self-reliant on other stock indicators.
With that being said, the MTF MACD indicator and its strategy are far from flawless and are best used as an entry signal tool for carefully-monitored trades. Before fully committing to this strategy, you should still screen stocks and read overall market trends with the best stock indicators.
No Histogram MACD Trading
Some traders like to keep their charts as clean and straightforward as possible, choosing to forgo the MACD histogram. You could plot a long-term moving average and a short-term Exponential Moving Average and look for intersections between these two to get a buy or sell signal. If a shorter moving trend crosses the long-term trend, you’ll get a sell signal that you’d do well to contextualize over indicators. This interaction between moving averages is called a “death cross”.
The exact opposite is true when the short-term signal crosses above the long-term signal. This particular interaction is called a “golden cross” and is a buy signal worth analyzing. Both names are somewhat dramatic, but they’re well-recognized amongst experienced traders for a good reason.
You could use a 200-day moving average as your long-term moving average and a 50 or 30 EMA as your short-term moving average. You can choose whether or not to incorporate a histogram, but in our opinion, it’s such a powerful data visualization tool that it wouldn’t hurt to at least toggle on once you find a death or golden cross.
The MACD indicator is, without question, one of the most versatile and valuable tools in any trader’s arsenal. It offers priceless insight into market momentum, reversals and upcoming breakouts that you can massively profit from. The indicator can also help you pinpoint entry signals in tight, 5-Minute charts, making it an all-time favorite amongst day traders.
Some experienced traders prefer to use a histogram to better visualize market momentum and volatility. Others prefer charting the MACD and Signal line independently, with both trading groups experiencing tremendous results. As long as you use the MACD indicator alongside other stock indicators, such as the RSI and various candle patterns, how you visualize data truly comes down to preference and taste.