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How to use moving-average convergence divergence (MACD)

In Trading

Many cryptocurrency traders prefer using MACD (Moving Average Convergence/Divergence) over Simple Moving Average (SMA) and Exponential Moving Average (EMA), as the MACD generates less lag in its trading signals. MACD signals whether shorter term price momentum is in the same direction as longer-term price momentum, and if not, whether the longer term trends are about to change.

MACD consists of a signal line, an average line and a histogram. The MACD signal line is derived from subtracting a shorter (faster) EMA from a longer (or slower) EMA.

EMAs are used over SMAs to improve sensitivity to shifts in price momentum and trends.

A 9-period EMA (by default) of the MACD signal line provides its average line. A MACD histogram illustrating the difference between the MACD signal and average lines is plotted, centered at zero, and oscillates up and down (with no upper or lower limits), depending on whether the MACD signal line is above or below the MACD average.

Unlike other oscillating indicators like the Relative Strength Index (RSI), MACD has no absolute range, and is more difficult in assessing overbought and oversold conditions than oscillators with a maximum and minimum value.

By default, most charting software plots the MACD using the 12- and 26-period EMA. As with moving averages, the shorter the moving averages, the faster or more sensitive they are to recent price changes. The advantage of using longer or slower moving averages would be in the fewer false or premature signals generated.

Trading signals are triggered from a MACD plot anytime there is a MACD-Price Divergence, a MACD Average Line Crossover or a MACD Centreline Crossover.

MACD Average Line Crossover

A moving average line crossover typically follows divergence and occurs whenever the MACD signal line crosses its average line. A MACD move above the average line is a bullish moving average crossover, while a move below the average line is considered bearish.

However, because these crossovers happen fairly often, many of the trading signals generated tend to be false, leading to premature trades yielding little profit or even significant losses.

A rising MACD (signal and average line) is considered bullish and reflects increasing positive momentum. MACD slopes up whenever there is a widening positive difference (or a narrowing negative difference) between the faster (or more sensitive) 12-period moving average and the slower (or less sensitive) 26-period moving average.

A falling MACD is bearish and reflects increasing negative momentum. MACD falls with a widening negative difference (or a narrowing positive difference) between the faster (or more sensitive) 12-period moving average and the slower (or less sensitive) 26-period moving average.

MACD Centerline Crossover

A bullish centerline crossover describes the MACD signal line rising above zero, while a bearish centerline crossover occurs when the MACD falls below zero.

Bullish centerline crossovers point to a momentum shifting from negative to positive, while bearish centerline crossovers are evidence of momentum becoming negative. As with the moving average crossover, centerline crossovers introduce a fair number of unreliable trading signals.

In the Bitcoin (BTC/USD) chart above, the first negative centerline crossover occurred in early March 2018 and generated a sell signal with Bitcoin (BTC/USD) priced at roughly USD9,000, only to be followed by a continued tumble to approximately USD6,400 a month later.

A week or so later (mid-April), BTC/USD experienced a positive MACD centerline crossover with BTC/USD trading at roughly USD8,500. Within a week, BTC/USD rallied another USD1,000 or so. An example of a false buy signal is that generated by the positive MACD centerline crossover in late-August, which was followed by a few up days but a sharp fall within a week of the buy signal.

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MACD-price divergence

MACD-price divergence is similar to the divergence described for RSI where the slope of the price and MACD may periodically diverge. Positive divergence occurs when the MACD histogram appears to have bottomed, while the price continues falling. A bottom in the MACD histogram requires it to form a series of higher lows.

Positive divergence reflects a fall in negative momentum and signals that the price may be about to reverse and begin a new uptrend. Negative divergence describes the opposite scenario, where the price is rising, but with less upward momentum, as reflected by a falling MACD histogram. With negative divergence indicative of waning bullish momentum, the likelihood of a price reversal to the downside increases.

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.

WRITTEN BY

Darren Chu, CFA

Darren Chu, CFA, is the founder of Tradable Patterns, publisher of daily technical analysis on Bloomberg, Thomson Reuters, Factset, Interactive Brokers, Inside Futures, and other partner websites. Before the launch of Tradable Patterns, Darren served as IntercontinentalExchange | NYSE Liffe's country manager for Australia, India, and the UAE, expanding his role to look after Liffe business development in APAC ex-Japan/Korea until his departure mid April 2014. Previously, Darren was with the TMX Group | Montreal Exchange, marketing Canadian futures and options across North America, London, Singapore and Hong Kong. Darren also launched and managed CMC Markets Canada's Chinese marketing and sales team, along with educational offering. Visit www.tradablepatterns.com for more information.