MACD stands for moving average convergence divergence and is one of the most popular technical analysis tools among traders. This indicator shows the relationship between two moving averages of an asset price. MACD was first developed by Gerald Appel in the late 1970s and is now one of the most critical components in the toolbox of both novice and professional traders.
What makes this tool so popular? The answer is simple: it helps traders observe market dynamics by assessing when a trend turnaround is possible. If you know when a rapid and significant change is possible, you can open promising positions with better returns.
What is MACD, and how does it work?
Fundamentally, MACD is an impulse oscillator that shows the ratio between two exponential moving averages of an asset price. We usually use a 12-day EMA (fast) and a 26-day EMA (slow) pulse. You can see how the values are set in the MetaTrader 5 desktop app.
The difference between these two EMAs forms the MACD line. Next to it goes a 9-day EMA of the MACD line, known as a signal line. This signal line shows possible buy or sell signals. The histogram demonstrates the difference between the MACD and signal lines, visually representing the momentum strength.
MACD is one of the default indicators on many popular trading platforms, including MetaTrader and the FBS trading app.
MACD trading strategies
To fully leverage the potential of the MACD indicator, traders can employ a few sophisticated strategies described below.
Signal line crossovers
A signal line crossing happens when the MACD line cuts through the signal line. These crossings can have two different meanings:
Buy signal
When the MACD line rises and crosses the signal line, it shows a bullish momentum.
Sell signal
Conversely, if the MACD line crosses the signal line going downward, it is a bearish impulse and a potential selling opportunity.
However, in volatile or sideways markets, these intersections can give false signals. It’s always a good idea to add more technical indicators or confirmation signals to increase the crossovers’ reliability.
Zero line crossovers
A zero line, also known as a center line, divides a chart into a positive and a negative area. It is formed by a combination of fast and slow EMA lines. The MACD line moves around this line. When the MACD line crosses the zero line, traders can confirm the direction of the prevailing trend.
When the MACD line crosses the zero line upwards, negative momentum switches to positive, which may indicate a potential uptrend.
Simply put, a trader can buy when MACD rises above the zero line and hold the position until the price returns below 0.
Crossing the zero line downwards indicates the move gives a potential downtrend.
A trader can sell when MACD drops below the zero line and close the trade when the price rises above zero again.
Remember, this approach works best for strong market movements and is less efficient in a sideways market, where it may cause losses.
Divergence analysis
The divergence between the MACD indicator and the asset price can be an early signal of an upcoming trend reversal. Finding such divergences can be very informative when you want to understand the underlying market dynamics.
Buy signal
A bullish divergence occurs when the price shows lower lows, while on the MACD, these values represent higher lows. This demonstrates that the bearish momentum is weakening, and an upward reversal may be possible.
Sell signal
A bearish divergence happens when the price reaches higher highs while the MACD indicator captures lower highs. This divergence signals that bullish momentum is weakening, and an downside reversal is possible.
MACD histogram analysis
The histogram visually illustrates the difference between the MACD and signal lines. Its behavior helps traders interpret the strength of momentum and possible changes to make better decisions about their entry and exit points.
Combining MACD with other indicators
While MACD is a potent tool, it can be even more effective when combined with other indicators.
Relative strength index (RSI)
While the MACD defines the direction and momentum of a trend, the RSI demonstrates overbought and oversold conditions. Combining these two indicators will help you better analyze the market by filtering out fake signals and confirming promising opportunities.
Exponential moving averages (EMAs)
Incorporating longer-period EMAs, such as a 200-day EMA, can help you better determine the overall trend direction. Traders might consider MACD signals that align with the direction indicated by these EMAs to increase the probability of successful trades.
How to optimize MACD settings
The default MACD settings are 12, 26, and 9, which work well in most situations. However, you may edit these values to tailor the indicator for your specific trading style and timeframes:
Short-term trading
If you choose settings like 5, 35, and 5, you will get more responsive signals, suitable for intraday trading.
Long-term trading
Conversely, if you choose higher settings, you can smooth out noise and align with extended investment horizons.
You may want to test different values on a demo account to identify those that will work for your specific trading instruments and strategies.
Limitations and other considerations
The MACD indicator is essential for many traders, helping them understand market dynamics and hinting at possible trend reversals. However, no matter how useful MACD is, it is not perfect: it can occasionally give false signals, especially in unstable or sideways markets.
Wise risk management is required, and you should always use stop-loss and position sizing. It is also a good idea to combine MACD signals with additional options, such as fundamental analysis and other technical indicators, to improve your decision-making and trading results.
You can build complex strategies for consistent profit-making if you learn all the MACD tricks and integrate the indicator with other analytics tools. What’s important is that you keep learning and adapting constantly: you cannot develop your setup once and for all and stick to a single trading strategy. A wise approach in trading is combining multiple tools available, learning by doing, and adapting your settings to your instruments and strategy.
FAQ
Why is the MACD indicator so popular among traders?
The MACD indicator is one of the most popular among traders and is supported by most trading platforms by default. The reasons for its popularity are simple: it is easy to use, and it helps traders observe market dynamics and make buy or sell decisions when a turnaround is possible.
Is the MACD indicator accurate?
The MACD indicator is quite accurate but can give false signals in volatile or sideways markets. To improve accuracy and overall trading results, it is better to combine MACD with other technical indicators and use fundamental analysis.
What trading styles does the MACD indicator support?
The MACD indicator is universal and works for most situations and trading styles. However, you may need to edit the default settings to make the indicator work better in your specific situation or for your preferred trading instruments. For example, choose 5, 35, and 5 in settings to get more responsive signals for day trading.
