Trading The MACD Indicator Like A Pro

Posted in: Advanced Trading Strategies, Trading Article, trading videos

One of the first indicators I ever experimented with was one developed by Gerald Appel in the late 1970s called the MACD indicator, otherwise defined as the moving average convergence divergence indicator. The MACD histogram was added in 1986.

Right from the start I used it as a technical analysis tool, applied the macd indicator to the daily chart and used it to measure an increase in momentum, the overall strength of the market as well as trend direction.

I used it for Forex and Futures trading but everything you are about to read applies to stocks, commodities, virtually any market you can think of.  It can make a very useful part of any trading strategy if you are keenly aware of the mechanics behind it.

 

MACD Default Settings

Setting the macd indicator on your chart is straightforward. Simply check the user guides for you charting platform on how to set up the indicator on your chart and if you want to change the standard macd settings as shown below, it will tell you how to do that.

As with any trading indicator, I always start with the input parameters that were set out by the developer and later determine if I will change the values.

The MACD default inputs are: 12, 26, 9 which represents the values for:

  1. Lookback periods for the fast line (12)
  2. Lookback period for the slow line (26)
  3. Signal EMA (9)

This leads us to how the macd calculates its output:

  1. The 12 period EMA calculates a number for this period
  2. The 26 EMA calculates a number for this period
  3. Subtraction of the 26 EMA result from the 12 EMA result
  4. A 9 period EMA is calculated from 26 EMA – 12 EMA

 

MACD Settings For Day Trading

As with any indicator, you can change the input values depending on your needs. Intraday traders may want a faster indicator to cut down on lag time due to their short term trading style. The search for the best settings for any indicator is a trap many of us have fallen into at least once in our trading.

The reason I always start with the default settings is because there are so many different combinations that can be used for any indicator. When you look at the MACD values, you have 3 that can be altered. The question should always be “will it make a difference”.

You must test any changes you make to ensure it actually adds to your trading plan.

That said, one very popular combination of the MACD is 3, 10, 16 which is a variation of the 3/10 oscillator. I highly suggest that before you start crunching numbers and looking for short term macd settings for faster signals, you know exactly how the MACD works and determine if it will benefit your own trading.

Do not be fooled by those who say there are best settings for day trading.  Indicators are simply derivatives of price, not a perfect trading tool.  The only difference is how fast the indicator reacts to price changes.  Most of us will probably be chopped to pieces if we rely only on a short term trading indicator as the basis for a trading system.

 

Relationship of MACD Line and Signal Line

The MACD line is faster than the signal line and is the result of the difference between the fast and slow moving averages. Many traders will use this line as a proxy for momentum and to make is simplier, think of it as measuring the rate of change of price.

The signal line in the MACD is slower due to it’s setting and traders will often use that as a trend determination tool either using multiple time frames or simply one trading chart.

Knowing that we measure trend and momentum, you may already see how we can use the MACD to actually trade with when we use both the MACD line and the signal line to alert us to a possible change in the market we are trading. The 2 line cross can be a very powerful indicator of trading potential in the market.

 

MACD Chart Analysis

We have set up the indicator on our chart and are going to use the standard settings as previously discussed and learn how to read the macd.

MACD Chart Trading

When we want to determine trend direction via the MACD, we look where the MACD line is in relation to the signal line. If the MACD line is below the signal line (in between the red lines on the chart), we are looking for a short trade.

If we see where the MACD line is above the signal line (between the green lines), this would indicate a market in an uptrend and you would be bullish on any trading setup.

As mentioned, we are really looking at the rate of change of price so even though the lines are crossed, price may be compressing. This is one reason that multiple time frame trading is suitable for this trading indicator. You’d simply look to short rallies during a MACD downtrend and buy pullbacks during an uptrend.

Entry and Exit Signals

Some traders will use a macd signal line crossover to buy or sell the market. You may want to consider other variables such as price structure, multiple time frame considerations and price action in conjunction with trading a simple cross.  Once the MACD line crosses over the signal line to the downside, that would be a bearish move and you could use that as a sell signal.

Conversely, if the MACD line crosses to the upside, you would be bullish and can use that as a buy signal.

Fast Line Hook Trade Entry

We spoke about the fast line being a proxy for momentum and there may be times where you will not want to wait for a complete crossover of the MACD to take a trade. I want to draw your attention to the black round circle at the top of the chart.

Here we see a pin bar has formed after a run up in price. Also notice the separation in the MACD indicator as price approaches this region (in the same region of previous resistance not seen on this chart) showing decent momentum in this market.

We see the separation decreasing as price slows down and then explodes to the upside but closes on its open as seen on the pin bar. This is a bearish sign. Bring your eyes to the fast line of the MACD and you can see it hook to the downside. Given the context of price action and structure, you could gain an early entry into a possible reversal.

Depending on the context of the chart, you can use the fast line hook as a buy signal or a sell signal.  These can be used to enter the market or as a profit taking indicator.

Does it matter? This is a weekly chart and you would have enter 5-6 bar earlier and been up over 120 pips before the breakdown.

What About Trading Divergence?

I am not going to cover using this for divergence trading simply because that will also take into account price action and structure.  I find the normal teachings about divergence has too many holes because if you trade just the indicator, you are setting yourself up for failure.

 

Using the Moving Average Convergence Divergence Zero Line

Another way we can use this indicator is to take advantage of the zero line and the fast line as a means of trade entry. Again, keep in mind the lagging nature of all indicators with this trading method and highly consider using multiple time frames for your trading.

Zero line MACD Trade Entry

You can see the change in trend when during the moving average crossover so we know we are looking for short trades. Once the fast line crosses the zero line, this would be a trade entry.

You can see how mechanical this is but also gets you in very late in the move.

You will see an inset box on this graphic. That is the daily chart and the red line indicates where, after the weekly trend turns down, you would enter on the daily chart using the zero line cross method. That black line is where you’d enter on the weekly chart two months later.

 

Trading With The MACD – Summary

With the macd we have a very useful technical analysis tool. It has quite a few uses and we covered:

  • How to determine the trend using the 2 line cross
  • How to read momentum using the fast line
  • Trade entry using a fast line hook
  • Trade entry using a zero line cross
  • The benefits of multiple time frame analysis

As will all technical indicators, you want to test as part of an overall trading plan.  Also be aware of the lag time using this indicator although for some traders it will be an advantage as you are not picking tops and bottoms.

You may also want to experiment, as with any moving averages, consolidation plays when the 2 lines of the MACD converge.  When this happens, price is usually in a range setting up a possible break out trade.

Test, back test, and forward test and you may find the MACD a valuable part of your trading process.

The following two tabs change content below.

CoachShane

Trader at Netpicks
Shane his trading journey in 2005, became a Netpicks customer in 2008 needing structure in his trading approach. His focus is on the technical side of trading filtering in a macro overview and credits a handful of traders that have heavily influenced his relaxed approach to trading. Shane started day trading Forex but has since transitioned to a swing/position focus in most markets including commodities and futures. This has allowed less time in front of the computer without an adverse affect on returns.

× Comments are closed.