MACD - Lesson on what it is, how to use
Here’s the basics of a MACD – I will say, I personally don’t use it, but I know it’s a popular indicator amongst newer traders.
What is a MACD?
A fairly straightforward indicator that calculates the difference between two exponential moving averages – of course this can be tweaked and modified but the standard settings seem to be 26 day and a 12 day.
Moving average convergence divergence (MACD), invented in 1979 by Gerald Appel, is one of the most popular technical indicators in trading. The MACD is appreciated by traders the world over for its simplicity and flexibility, as it can be used either as a trend or momentum indicator.
Click on the image for the lesson on MA's.
The 12 day is considered the fast one and the 26 the slow one – so when people refer to a fast or slow line it is to this they are referring.
The calculation is then done on the closing price of both EMA’s.
The second measurement is known as a trigger – see image for the 3 components (in orange) the trigger is often, a nine-day EMA of the MACD itself is plotted as well.
Histogram - The MACD histogram is an elegant visual representation of the difference between the MACD and its nine-day EMA.
The histogram is positive when the MACD is above its nine-day EMA and negative when the MACD is below its nine-day EMA.
If prices are rising, the histogram grows larger as the speed of the price movement accelerates, and contracts as price movement decelerates. The same principle works in reverse as prices are falling.
How to use it?
The MACD generates a bullish signal when it moves above its own nine-day EMA, and it sends a sell sign when it moves below its nine-day EMA.
What does this mean?
Because there are two moving averages with different “speeds”, the faster one will obviously be quicker to react to price movement than the slower one.
When a new trend occurs, the faster line (MACD Line) will react first and eventually cross the slower line (Signal Line).
When this “crossover” occurs, and the fast line starts to “diverge” or move away from the slower line, it often indicates that a new trend has formed. This in essence is Divergence…
What you will notice here in the recent Bitcoin move; is when the cross happened the price fell.
But unfortunately, the divergence trade is not very accurate, as it fails more than it succeeds.
So, it’s not as easy as plugging in a MACD and running with it!
The MACD histogram is the main reason why so many traders rely on the indicator to measure momentum, due to it responding to the speed of price movement.
Many traders use the MACD indicator more frequently to gauge the strength of the price move than to determine the direction of a trend.
In the image below; I have removed the EMA’s and kept only the histogram to show the example.
You will see that from point A to B on the chart and how it is represented in the histogram & then again from point C to D – both showing bullish momentum from a low point.
And in this example below; the Histogram shows more negative strength from X to Y.
The Truth
No indicator is perfect – no trader is perfect; two wrongs won’t make it right. Some traders swear by MACD and others avoid it. The one thing I can say, is if you keep to its rules then you could make it work for you. Using the indicators histogram over price or entries with Divergence might be what your looking for, then MACD is useful. But don’t rely on especially as the only entry/exit tool.
Why did I write this if I don’t use it? Like many indicators, they are lagging – the issue is most educational content online shows MA’s, MACD’s, RSI. Newer traders assume there is some holy grain in terms of indicators. There isn’t – all of what indicators say, can be seen in price – after all it’s what they are calculated on. I’ve written this to highlight the logic of a MACD for newer traders looking or using it. To at least highlight what it is your looking at.
Hope it helps somebody out there!
For more educational content, see the links below in "related ideas".
Disclaimer
This idea does not constitute as financial advice. It is for educational purposes only, our principle trader has over 20 years’ experience in stocks, ETF’s, and Forex. Hence each trade setup might have different hold times, entry or exit conditions, and will vary from the post/idea shared here. You can use the information from this post to make your own trading plan for the instrument discussed. Trading carries a risk; a high percentage of retail traders lose money. Please keep this in mind when entering any trade. Stay safe.
What is a MACD?
A fairly straightforward indicator that calculates the difference between two exponential moving averages – of course this can be tweaked and modified but the standard settings seem to be 26 day and a 12 day.
Moving average convergence divergence (MACD), invented in 1979 by Gerald Appel, is one of the most popular technical indicators in trading. The MACD is appreciated by traders the world over for its simplicity and flexibility, as it can be used either as a trend or momentum indicator.
Click on the image for the lesson on MA's.
The 12 day is considered the fast one and the 26 the slow one – so when people refer to a fast or slow line it is to this they are referring.
The calculation is then done on the closing price of both EMA’s.
The second measurement is known as a trigger – see image for the 3 components (in orange) the trigger is often, a nine-day EMA of the MACD itself is plotted as well.
Histogram - The MACD histogram is an elegant visual representation of the difference between the MACD and its nine-day EMA.
The histogram is positive when the MACD is above its nine-day EMA and negative when the MACD is below its nine-day EMA.
If prices are rising, the histogram grows larger as the speed of the price movement accelerates, and contracts as price movement decelerates. The same principle works in reverse as prices are falling.
How to use it?
The MACD generates a bullish signal when it moves above its own nine-day EMA, and it sends a sell sign when it moves below its nine-day EMA.
What does this mean?
Because there are two moving averages with different “speeds”, the faster one will obviously be quicker to react to price movement than the slower one.
When a new trend occurs, the faster line (MACD Line) will react first and eventually cross the slower line (Signal Line).
When this “crossover” occurs, and the fast line starts to “diverge” or move away from the slower line, it often indicates that a new trend has formed. This in essence is Divergence…
What you will notice here in the recent Bitcoin move; is when the cross happened the price fell.
But unfortunately, the divergence trade is not very accurate, as it fails more than it succeeds.
So, it’s not as easy as plugging in a MACD and running with it!
The MACD histogram is the main reason why so many traders rely on the indicator to measure momentum, due to it responding to the speed of price movement.
Many traders use the MACD indicator more frequently to gauge the strength of the price move than to determine the direction of a trend.
In the image below; I have removed the EMA’s and kept only the histogram to show the example.
You will see that from point A to B on the chart and how it is represented in the histogram & then again from point C to D – both showing bullish momentum from a low point.
And in this example below; the Histogram shows more negative strength from X to Y.
The Truth
No indicator is perfect – no trader is perfect; two wrongs won’t make it right. Some traders swear by MACD and others avoid it. The one thing I can say, is if you keep to its rules then you could make it work for you. Using the indicators histogram over price or entries with Divergence might be what your looking for, then MACD is useful. But don’t rely on especially as the only entry/exit tool.
Why did I write this if I don’t use it? Like many indicators, they are lagging – the issue is most educational content online shows MA’s, MACD’s, RSI. Newer traders assume there is some holy grain in terms of indicators. There isn’t – all of what indicators say, can be seen in price – after all it’s what they are calculated on. I’ve written this to highlight the logic of a MACD for newer traders looking or using it. To at least highlight what it is your looking at.
Hope it helps somebody out there!
For more educational content, see the links below in "related ideas".
Disclaimer
This idea does not constitute as financial advice. It is for educational purposes only, our principle trader has over 20 years’ experience in stocks, ETF’s, and Forex. Hence each trade setup might have different hold times, entry or exit conditions, and will vary from the post/idea shared here. You can use the information from this post to make your own trading plan for the instrument discussed. Trading carries a risk; a high percentage of retail traders lose money. Please keep this in mind when entering any trade. Stay safe.
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