A Beginner’s Guide to Moving Average Convergence Divergence (MACD)
A host of specialized indicators can perform crypto trading trend analysis, but none is as prominent and straightforward as the Moving Average Convergence Divergence (MACD).
The MACD helps deduce whether a current short-term price movement follows the same trajectory as the overall longer-term price movement. As its name suggests, you can do it by converting averages into momentum swings via subtractions of the longer-term average from the short-term one.
Understanding how the MACD works could greatly appreciate its high consideration rate by many traders as the go-to trend-following crypto trading technical indicator.
Components of MACD
The MACD comprises three critical components, as illustrated in the graph below:
The MACD line
It consists of the 12 days exponential moving average (EMA). EMAs are more preferable to regular moving averages due to their price movement sensitivity. The MACD line is arrived at by subtracting the 26 days EMA (26 EMA) from the 12 days EMA (12 EMA)
The Signal Line
It is the 9 days EMA (9 EMA) of the MACD line. The line’s interaction with the MACD line regarding divergence, convergence, and crossing creates the trading signals.
It shows the difference between the MACD line and the signal line. It is positive when the MACD line is higher and negative when the signal line is more elevated.
Trading Signals of the MACD
While the terminologies employed may appear complicated, the precise visual articulation makes this indicator reasonably simple. Key trading signals include:
MACD and Signal Line Crossover
Refers to the crossing of the MACD line and the signal line. A cross may be bullish or bearish.
A bullish situation is when the MACD line moves above the Signal line. It is a positive signal usually accompanied by a strong upwards rallying of market prices. It provides a strong market incentive to buy since the prices are rising.
A bearish condition is, in turn, a negative situation illustrated by the MACD line crossing and falling below the signal line. Such a situation is strongly associated with market prices crashing, usually an indicator of selling shares and avoiding value loss.
It must, however, be pointed out that the MACD and signal line repeatedly cross. Before a trade decision, other MACD signals, as well as other indicators such as RSI and volume, should also be put into consideration.
MACD and Zero Line Crossover
The zero lines are the midpoint of the MACD oscillator. Also called the centerline, it is the level where the MACD line is equal to zero, meaning the 26 EMA and the 12 EMA are equal. The line is. Therefore, horizontal fixed at zero that also acts as the base for the histograms.
When the MACD line crosses above the zero lines, it signifies a bullish market hence stimulating a buy response. Occurring only when the 12 EMA is higher than the 26 EMA, the crossing means the short-term prices are better than the longer-term ones. The MACD, on crossing below the zero lines, indicates a bearish condition stimulating a cell response. That is because longer-term conditions are better than short-term ones.
Due to the nature of repeated crossings between the two lines during a trading day, it isn’t a mutually exclusive condition to sell. One must put other signals into consideration.
A MACD-price divergence shows a situation where the MACD movements do not reflect the price movements. A good depiction is observing the MACD position when the price prints a swing high (peak)or a swing low (trough).
With divergence, a bullish condition is observed when;
- The price prints a lower low while the MACD indicator prints a higher low
- The price prints a higher low while the MACD indicator prints a lower low
The graph below shows the first condition of a bullish divergence.
A bearish condition is observed when
- The price shows a higher high while the MACD high shows a lower high
- The price shows a lower high while the MACD high shows a higher high
The graph below shows the first condition of bearish divergence on its left half, just before discussing the bullish divergence.
Divergence is also not a complete cause for buying or selling; several indicators such as RSI, stochastic, and other MACD signals should be considered. Ascertaining that there is a clear space between the highs for bear markets or lows for bull markets and a big difference between the two highs or lows is essential.
Observation of both the MACD and signal lines’ general movements can also stimulate a buy or sell response.
When both lines move up together, the markets are giving a positive sign implying a bullish condition. When both lines fall, the market condition becomes bearish. The observations work well in tandem with other signals.
While the MACD is a good trend following mechanism, it can indicate overbought/oversold stocks in the market.
The condition is identified when there is a big and lengthy gap between the MACD line and Signal line and between both lines and the zero line. The over-extended market condition, as a result, prompts an eventual pullback, signaling a sell response from traders.
The success of MACD as a trend following trade indicator lies in the ease of deducing movements. All a trader, even a beginner, needs to do is follow the lines and their interactions.
MACD’s various components can produce various conflicting signals at times. Traders will be all the wiser if they consider all the details and factors in all the five signals. When an overwhelming majority of signals point to either a bullish or bearish condition, the decision to buy or sell becomes more reasonable. Even then, other types of technical indicators should be considered.