Trading With The MACD Indicator

The MACD ( moving average convergence divergence ) indicator designed by Gerald Appel is a trend-following/momentum indicator that uses 2 exponential moving averages (EMA) to:

+ Give buy and sell signals to enter and exit the market

+ Show bullish divergence/bearish divergence and negative divergence as well

+ Helps determine trend direction in both price and momentum

Some traders will also include the histogram that will cross the zero line when the EMAs cross in either direction.

MACD Settings

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

+ The lookback periods for the fast line (12)

+ The lookback period for the slow line (26)

+ Signal EMA (9)

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.

MACD Calculation

This leads us to how the MACD calculates its output using the closing periods:

+ The 12 period EMA calculates a number for this period

+ The 26 period EMA calculates a number for this period

+ Subtraction of the 26 EMA result from the 12 EMA result

+ A 9 period EMA is calculated from 26 EMA – 12 EMA

How does the indicator work?

The MACD indicator is generated by subtracting two exponential moving averages (EMAs) to create the main line (MACD line), which is then used to calculate another EMA that represents the signal line.

What is the signal line?

Signal line is a 9 EMA of MACD line.  When the MACD line and signal line cross, it’s usually considered a trend reversal signals, especially when they happen away from the zero line.

MACD Settings For Intraday Trading

As with any technical analysis 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.

You must test any changes you make to ensure it actually adds to your trading plan.  Often times, a faster trading indicator will give many false signals so you must be aware of the trade-off.  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.

How To Read The MACD Indicator

The MACD is based on the difference between two exponential moving averages (EMAs) and a signal line that is plotted on the chart.

Here are the steps to read the MACD indicator:

1. Look for the MACD line: The MACD line is the difference between the 12-period and 26-period exponential moving averages (EMAs). It is typically displayed as a histogram or a line chart. The MACD line represents the momentum of the market trend.
2. Look for the signal line: The signal line is a 9-period EMA that is plotted on top of the MACD line. The signal line is used to identify potential buy or sell signals.
3. Look for crossovers: When the MACD line crosses above the signal line, it generates a bullish signal, indicating that the momentum of the market trend is shifting to the upside. Conversely, when the MACD line crosses below the signal line, it generates a bearish signal, indicating that the momentum of the market trend is shifting to the downside.
4. Look for divergences: Divergences occur when the MACD line and the price action of the asset being analyzed are moving in opposite directions. A bullish divergence occurs when the MACD line is moving up while the price is moving down, which could indicate a potential reversal to the upside. A bearish divergence occurs when the MACD line is moving down while the price is moving up, which could indicate a potential reversal to the downside.
5. Look at the MACD histogram: The MACD histogram represents the difference between the MACD line and the signal line. When the MACD line is above the signal line, the histogram is positive, indicating bullish momentum. When the MACD line is below the signal line, the histogram is negative, indicating bearish momentum.

The MACD line is faster than the signal line and is the result of the difference between the fast and slow EMAs.

Momentum Oscillator

When you see a signal line crossover of the faster MACD line over the signal line, we see a visual representation of  a change in the direction of momentum.

There are traders that will use the shift in momentum as the direction they want to trade in.  Momentum direction and price trend direction is not always the same direction.

 Price Trend Direction

A crossover of the signal line over the zero line is often used for trend direction .  Traders can use the momentum aspect as a sign of a pending trend change.  The zero line cross can be a confirmation of trend.

+ Bearish signal – Fast MACD line crosses from above to below the slow line

+ Bullish signal – Fast line crossover from below to above the slow line

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 indication of trading potential in the market and is my preferred approach.

Zero Line Crossover

MACD crossing above zero is considered bullish, while crossing below zero is a bearish signal.  This is also expanded to include bullish and bearish momentum when the lines cross regardless of which side of the zero line.

MACD TRADING STRATEGY

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.

For this strategy, we are using the momentum feature of the MACD plus breaks of swing highs/low that also take place when an imbalance of buyers/sellers are present.

When we want to determine trend direction via the MACD for this strategy, we look where the MACD line is in relation to the signal line.

Strategy Details (Uptrend Example)

+ Mark off current swing high and low points

+ Price breaks swing high confirms uptrend is still in place

+ EMA cross on the MACD shows momentum to the upside

+ Use buy stop orders at high of candle that broke swing high/turned the indicator bullish via the crossing

Can we improve on this?

We can use multiple time frame trading by trading in the direction of the higher time frame momentum.

This is a one hour chart and the daily chart has bearish momentum.  We would only trade breakdowns through support with confirmation via MACD.

If price gaps through support, we would not take the trade.

The power of this approach is we have the bearish daily chart momentum at our backs when going short on the smaller time frame.

MACD Combinations

My favorite combination of trading indicators is the MACD + Keltner channels and price action.

+ Keltner channels would show a market that is extended and prime for a retrace

+ We look for a piercing of the upper or lower Keltner channel to show extension

+ MACD can show loss of momentum or divergences

+ Keltner is set to 20 periods with a 2.25 multiplier

Price is making lower lows while piercing the lower Keltner channel.  This is showing an extended market (oversold conditions) and while traders love to counter trend trade, we need another event to happen.

What Is a Divergence?

Divergences form when the MACD heads in one direction while price movement is in the other direction

In the black circle, we have price break lower, pierce the channel, and then we get a cross up.  This cross shows momentum to the upside while price is making a lower low and is known as positive divergence.

We want to trade the reversal as this is our buy trading signal.

Entry can be a buy stop over the red candle, green candle, or a break of the small trading range.

Targets will be the middle channel line and the upper Keltner band.  Trend reversals can often start from this condition so having a trading plan that includes some type of trailing stop method may be worthwhile.

Frequently Asked Questions

How Do You Use MACD as an Indicator?

To use MACD as an indicator, you need to understand how it works. The MACD is made up of two lines, the MACD line and the signal line. When the MACD line crosses above the signal line, it is considered a bullish signal, indicating that the stock’s momentum is shifting upward. When the MACD line crosses below the signal line, it is considered a bearish signal, indicating that the stock’s momentum is shifting downward. Traders use the MACD to identify potential buy and sell signals, as well as to confirm the strength of a trend. By analyzing the MACD line and signal line, traders can gain insight into the direction and strength of a stock’s momentum.

Why Does MACD Use The Values 12 and 26?

The MACD (Moving Average Convergence Divergence) trading indicator uses 12 and 26 as its default input values for the calculation of its two lines – the MACD line and the signal line. These values were chosen by the creator of the indicator, Gerald Appel, based on his research and experience in the financial industry. The 12 and 26 values represent the number of periods used to calculate the exponential moving averages (EMAs) for the MACD line and the signal line, respectively. The MACD line is calculated by subtracting the 26-period EMA from the 12-period EMA, while the signal line is a 9-period EMA of the MACD line.

What is a MACD Buy Signal?

A MACD buy signal is when the MACD line crosses above the signal line, it’s considered a buy signal, indicating that the stock’s momentum is shifting upwards and it may be a good time to buy. However, it’s important to note that no trading indicator is foolproof, and traders should always do their own research and analysis before making any investment decisions.

Is MACD a Good Indicator?

MACD (Moving Average Convergence Divergence) is a popular trading indicator used by many traders. It’s a trend-following momentum indicator that shows the relationship between two moving averages of an asset’s price. Many traders find MACD to be a useful tool for identifying trends and potential trend reversals. It’s important to combine MACD with other technical analysis tools and to have a solid understanding of market fundamentals before making any trades. Whether or not MACD is a good indicator depends on the individual trader’s strategy and risk tolerance.

What is the Difference between MACD and RSI?

MACD (Moving Average Convergence Divergence) and RSI (Relative Strength Index) are both popular trading indicators used by traders to analyze market trends and make trading decisions. While both indicators are used to identify overbought and oversold conditions in the market, they differ in their approach and calculation.

MACD is a trend-following momentum indicator that shows the relationship between two moving averages of an asset’s price. It consists of a MACD line, a signal line, and a histogram. The MACD line is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA, while the signal line is a 9-period EMA of the MACD line. The histogram shows the difference between the MACD line and the signal line.

RSI is a momentum oscillator that measures the magnitude of recent price changes to evaluate overbought or oversold conditions. It calculates the ratio of upward price movements to downward price movements over a specified period of time, usually 14 periods. RSI values range from 0 to 100, with readings above 70 indicating overbought conditions and readings below 30 indicating oversold conditions.

While both MACD and RSI are used to identify market trends and overbought/oversold conditions, MACD is a trend-following indicator that uses moving averages to calculate its values, while RSI is a momentum oscillator that measures the magnitude of recent price changes.

Conclusion

The MACD indicator is a powerful tool for traders of all levels. By using it to identify trends, momentum, and potential entry and exit points, you can make more informed trading decisions and increase your chances of success. Remember to always keep an eye on market conditions and use the MACD in conjunction with other indicators and analysis techniques for the best results.