An oscillator of momentum, the Moving Average Convergence Divergence indicator is usually employed in trend trading. Despite being an oscillator, it is rarely employed to spot overbought or oversold positions. It shows as two lines that oscillate without boundaries on the graph. Similar to a two moving average technique, trading signals are generated by the crossing of the two lines.
Is MACD a good indicator?
The Moving Average Convergence/Divergence oscillator (MACD), created by Gerald Appel in the late 1970s, is one of the most straightforward and efficient momentum indicators known. By deducting the longer moving average from the shorter one, the MACD converts two trend-following indicators, or moving averages, into a momentum oscillator. Thus, the MACD offers trend following and momentum, the best of both worlds. As the moving averages converge, intersect, and diverge, the MACD moves above and below the zero line. To generate signals, traders should watch for signal line crossovers, centerline crossovers, and divergences. The MACD is unbounded, which makes it less effective at spotting overbought and oversold levels.
The best way to use this indicator is when we have long trends and no ranging markets. In ranging markets we will get many signals when we check the MACD indicator and most of them will be false. Yet even in ranging markets we can make use of this indicator in combination with support and resistance, RSI, stochastic, moving averages or Ichimoku.
How the Moving Average Divergence Convergence indicator works
The moving average convergence divergence consists of 4 parts.
- MACD line (26 EMA – 12 EMA = blue line)
- Signal line (9 EMA of the blue line is the orange line)
- Histogram
- Zero line (balance line between the two moving averages 26 EMA and 12 EMA. Below the zero line means that the 26 previous periods average is higher then the 12 previous periods average which means we are in a downtrend. Above the zero line means that the previous 12 periods average is higher then the 26 average which means we are going up)
Long and short signals
- MACD crossover
- Divergence
- Zero line crossover
We typically go long when the blue line is crossing the orange line from below to above or when the zero line is crossed from below or when we see a divergence. We go short on occasions when the blue line is crossing the orange line from above to below or when the zero line is crossed from above towards below. These are general signals and offer a lot of false signals. Further in this article we talk about where to seek confirmation that a signal will be false or accurate.
moving average convergence divergence histogram
The histogram is a very important piece of the puzzle. As it will show us how much momentum we are having. The bigger the histogram, the more momentum we are encountering. A red histogram shows us that momentum is bearish. A green histogram shows us bullish momentum. Small histograms are indicating consolidation or ranging markets and our more dangerous as they will give us more false crossovers.
How do you calculate Moving Average Convergence Divergence MACD?
The MACD formula is as follows. The 12-day Exponential Moving Average (EMA) less the 26-day EMA forms the MACD line. These moving averages are computed using closing prices. The indicator is shown along with a 9-day EMA of the MACD line to serve as a signal line and detect turns. The MACD Histogram shows the discrepancy between the MACD and the signal line, which is the 9-day EMA. When the MACD line is above its signal line and when it is below its signal line, the histogram is positive.
The MACD is often set at 12, 26, and 9, though alternative values can be utilized depending on your trading style and objectives. By deducting the value of a 26 period Exponential Moving Average (EMA) from a 12 period EMA, an approximation of the MACD may be computed. Continuously moving toward and away from the longer EMA is the shorter EMA. As a result, MACD fluctuates close to zero. A 9 period EMA of the MACD line is used to construct a signal line.
The main line is de MACD line which is blue in this case. The higher above the zero line, the bigger the difference between the two parameters of the indicator. The difference between the 26 period and the 12 period. When the indicator goes higher, recent prices are going up so we can be bullish. If the indicator goes lower, recent prices are going down so we are bearish. The zero line is when prices of the 26 period and the 12 period are in equilibrium. Above the zero line is considered uptrend, below zero in considered downtrend.
The signal line in orange is the EMA or exponential moving average of the 9 former periods of the blue line, macd line.
How to read moving average convergence divergence?
Signals are given when the two lines are crossing. If the blue line is crossing the orange from above to below, we are bearish. If the blue line crosses from below to above, we are bullish. Generally speaking, when the macd line crosses the signal line from far below zero, we can expect an uptrend. Price has been falling very fast, so a reversal is on it’s way. We can not take a position at that time because the indicator gives a lot of false signals. Maybe we are only going to see a very small recovery to the upside and then continue the move to the downside. Therefore we need to look for confirmation in other indicators or situations.
If for example the RSI or Stochastic indicator shows a high overbought level. We have already one confirmation that the next move will be up. Identifying an important support level around that price would be a third confirmation that the reversal is coming. A forth signal could be to wait for a crossover between two moving averages on the chart. Or to wait until the macd indicator crosses the zero line.
In above image the RSI is showing oversold while the MACD has a crossover. This could be a signal to take a long position but this is risky and will have a lower winrate then waiting until the zero line is crossed on the indicator, as we see in the image “crossing the zero line”. The downside here is that we only take a smaller part of the move. Another way is to take a small position on the crossing of the indicator lines and take another position once the zero line is crossed. We can also use two moving averages as our final confirmation that the trend is possibly up.
How to deal with fake signals or faulty signals from MACD indicator
As we can see on the image, NVIDIA reached a bottom around $ 130, the RSI indicating oversold, after that we see a crossover of the moving average convergence and divergence. Would be a signal to take in a long position for many eager traders. But price is consolidating and not moving up the first 24 hours on this hourly chart. The moment it starts moving up is when the zero line is crossed in the MACD indicator. Where you can see “Long Position”.
In a ranging market, the moving average divergence-convergence will give many signals or crossovers. Usually they are an indication that a bullish trend is emerging. Yet we have to wait to see a confirmation that the price is going up by waiting until the zero line is crossed. The same confirmation can be found with using two moving averages.
In this case we have :
- RSI indicating oversold (1st indication)
- Bottom reached or strong support zone around $ 130 (2nd indication)
- MACD crossover (but we are in consolidation)
- Zero line is crossing to the upside (3rd indication)
- EMA 9 is crossing EMA 21 to the upside (4th indication)
Best time frame to use the moving average convergence divergence indicator?
If we are using the indicator in a trending market where we clearly have an uptrend or a downtrend, then we can use it on no matter what time frame. If we are looking to profit from pullbacks, ranging markets, consolidation periods … then we better use the 15M, 30M or the 1H time frame.
Summary
We have 4 confirmations that our moving average divergence convergence crossover might give us a bullish result.The more confirmations we can find after a crossover happens, the more likely price is going to move in our desired direction. It does not happen very often, that we can find 4 confirmations. In most cases 3 will do. Taking a position on only 2 confirmations is risky. Taking a position on every crossover of the indicator will likely have a less than 50% winrate. Especially in a ranging or consolidating market.