The Moving Average Convergence/Divergence (MACD) is a popular trading indicator often favoured for its simplicity and ability to give strong trading signals.
The MACD is a trend-following indicator that signals whether shorter-term price momentum is in the same direction as longer-term price momentum, and if not, whether a trend change is close.
MACD has four components:
- The MACD line
- Signal line
- Zero line
The MACD line is calculated by subtracting the 26-EMA from the 12-EMA. EMAs are used over regular moving averages to improve sensitivity to price momentum and trend changes.
The signal line is, by default, a 9-period EMA. When combined with the MACD line, the convergence, divergence and crossing of the two lines are the basis of many trading signals.
The zero line is simply the level at which the MACD line would be zero. It shows the level where the 26-period EMA and the 12-period EMA are the same.
Finally, the histogram represents the distance of the MACD line from the signal line. It will either be positive when the MACD line is above the signal line, or negative when the signal line is above the MACD.
Unlike other oscillating indicators such as the Relative Strength Index (RSI), the MACD has no absolute range, so it isn’t suitable for assessing overbought and oversold conditions like oscillators with a maximum and minimum value.
Generating trading signals
MACD and signal line crossover
The most common trading signal generated by the MACD indicator is when the two oscillating lines crossover.
- Bullish = when the MACD line moves above the signal line.
- Bearish = when the signal line moves above the MACD line.
However, because these crossovers happen fairly often, there are a lot of false positives. You have to combine these signals with others to generate a trading decision.
Here are a couple of examples.
Back during the 2017 bull run, a bearish 1D cross on the MACD indicator could have told you to sell your Bitcoin right at the top.
More recently, in 2019 some 1D MACD crosses could have generated you some tasty profits. The green arrows show the buy signals and the red arrows show the sell signals.
You may notice the period between the red arrow and the second green arrow on the MACD indicator where there are some crosses to be considered. Why aren’t they highlighted as signals?
In hindsight, these crosses back and forth showed uncertainty and should not have been traded. The quick succession of crosses shows this. In the moment, traders would have been able to recognise whether to trade these signals or not based on other indicators such as volume and RSI.
When the MACD line and signal line are rising together it’s considered bullish and conveys increasing positive momentum.
A falling MACD is bearish and reflects increasing negative momentum.
MACD zero line Crossover
A bullish centerline crossover describes the MACD signal line rising above the zero line, while a bearish centerline crossover occurs when the MACD falls below the zero line.
As with the moving average crossover, centerline crossovers introduce a fair number of unreliable trading signals and must be used in conjunction with other signals.
MACD can be observed with price to find areas of divergence, which can give another trading signal.
Bullish divergence can be found when:
- Price prints a higher low and MACD prints a lower low.
- Price prints a lower low and MACD prints a higher low.
Bearish divergence can be found when:
- Price prints a higher high while MACD prints a lower high.
- Price prints a lower high while MACD prints a higher high.
See in the example below where price shows a lower low, while MACD shows a higher low. This signals a trend reversal is imminent.
Putting it all together
We have established that MACD can produce lots of trading signals and show the momentum of a price movement. Due to the number of signals, traders have to be careful and validate their ideas with other parts of their trading strategy.
One can take the four possible signals we have discussed here to generate an ultimate MACD signal. If you spot bullish divergence, a bullish cross, the MACD is rising and a bullish cross of the zero line occurs, you’ve found a bull signal much stronger than any of these signals on their own. It’s still not guaranteed, but it carries more weight.
Just like other charting techniques, the longer time frames hold more weight than the shorter ones. A bullish cross on the 1D chart means substantially more than a bullish cross on the 1-minute chart.
Try out your trading signals by trading crypto on Liquid.
This content is not financial advice and should not form the basis of any financial investment decisions nor be seen as a recommendation to buy or sell any good or product. Trading cryptocurrency is complex and comes with a high risk of losing money, particularly if you trade on leverage. You should carefully consider whether trading cryptocurrencies is right for you and take the time to learn how trading works and decide how much money you are prepared to lose.
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